Rules Based Credit Scoring.

The validity and usefulness of credit scoring for businesses has been debated, sometimes intensely, for many years. Articles have been written about the pros and cons, and why you should or should not use a credit scoring approach. You may believe that credit scoring is not valid for customer analysis in your company, whether for screening new accounts or performing existing account reviews. In reality, you are using, perhaps unknowingly, what is referred to as "rules based" scoring to make your credit decisions. While the word "customer" appears frequently below, the concepts of rules based scoring apply equally well to suppliers, partnering arrangements, or any situation where the relative strength or weakness of a business is desired.

What Is "Rules Based" Scoring?

As a method of evaluating customers, rules based scoring is perhaps the simplest to understand, most logical in its format and the easiest to implement. Rules based scoring--sometimes referred to as "judgmental scoring"--is a method by which the creditworthiness of a customer can be determined through application of a formula, or a set of rules. Simplistically, rules based scoring is a series of questions about the customer that need to be answered. (For example, "Has the company been in business for longer than 10 years? Yes or No.") Once answered, a quantifiable value can be placed on the answers. (For example, if "Yes, the customer has been in business longer than 10 years, then 50 points, otherwise no points.") When all questions are completed, all of the results are "plugged" into a formula to come up with a single number. That number, or score, is compared against a "scale" to determine the risk level of the account. The credit practitioner can then determine a course of action based on the "score" of t hat account. As already indicated, even without a specified method or formula in place, you are probably performing this process in making decisions now. "How long has he been in business?" "What do other suppliers have to say?" "Is there agency information available and, if so, what does it say?" are questions you ponder. The answers you derive are mentally weighed against a scale of what you consider acceptable or risky, and, based on that result, you make your decision--rules based scoring!

Early attempts at rules based scoring were referred to as a "credit matrix" process, with the questions down the left-hand side of the matrix, and the possible answers across the top of the matrix. This "scorecard" was completed for customers and the results tallied at the bottom of the columns, with various point levels given for different answers. When the total was determined, it was checked against a scale--usually 1 to 100, or 1 to 10, or 1 to 6, etc.--where one end of the spectrum represented comfort and the other concern. Based upon the position against the scale, different decisions could be made. The questions were, typically, a Yes/No approach for ease of application by the credit department, since this methodology was, for the most part, a manual exercise.

Rules based scoring is nothing more than an attempt to determine the "health" of your customer. To use an analogy, consider a thermometer to take your child's temperature. Under normal, healthy conditions, if the thermometer reads 98.6 degrees, your child (read customer) is normal. Even if the thermometer reads somewhat higher, your child probably is not displaying any unusual symptoms, and you, therefore, are not terribly worried. However, as the temperature creeps higher, your child begins to display abnormal behavior--they get moody, quiet, or listless. You become somewhat more concerned, and probably take some corrective measures to try to assist the child. As the temperature gets significantly higher, more urgent courses of action are needed. You get the picture! Rules based scoring is an approach to "taking the customer's temperature"--an attempt to quickly and easily determine the relative measure of the customer's health, leading to appropriate courses of action.

With the computerization of the "rules based" credit matrix, the ability to apply answers to the questions with other than a "Yes" or a "No" has become considerably easier, and, most importantly, it is now possible to assign "emphasis" to the responses to the various rules. The credit practitioner can assign "weights" to his scorecard. ...