Managing Customer Credit Risk in Tough Times
In a recent webinar, longtime Credit Today contributor Bob Shultz offered an insightful presentation on portfolio analysis in tough economic times.
Part of his presentation covered "landmines" to watch out for in your credit analysis process. He broke these into two key areas: business sustainability and ability to pay.
Customer's Business Sustainability
Here, Shultz listed four key things to look for:
1. Change in ownership: The first step is to find if the owner or structure of the company has changed. If yes, try to understand why did the change happen, who is the new owner, what is their background, and ultimately, what is their future action plan. These questions will help you get a better picture of who the "new" customer is and the expectations going forward.
2. Change in bank behavior: Another landmine to watch out for is any change in bank conduct, be it in terms of the restrictions or the capacity. It could be a reflection of what banks think about these customers and their financial stability in the long run.
3. Erosion of equity: Obviously, if equity is eroding, that's a real problem. The key thing is to pay attention to the rate of decline in relation to the business's equity.
4. Supply chain disruptions: While this is expected and understandable, it is always better to understand what went wrong. If your customer is facing critical supply chain disruptions, it could severely impact their ability to get back in business in due time. Even if they have a quick fix, try to find if there is a long-term plan to handle the disruption if the current situation persists.
Customer's Ability to Pay
Here Shultz offered up the following red flags:
1. Changes in payment behavior: Monitor any changes in customer's payment behavior. If you see a drop, reach out and try to get a promissory note or guarantee for the payment commitment.
2. Change in customer management behavior: Has there been a drastic change in customer management behavior? For example, have they suddenly become evasive, refusing to meet and not providing answers to any questions? It could be a potential indicator of fraud or a pending bankruptcy.
3. Negative payment trend in reports: It is essential now more than ever to watch out for any negative payment trend in trade credit bureaus, or industry trade groups reports.
4. Erosion of liquidity and working capital: Track cash. You want to know the amount of cash they have to stay afloat even if they do not generate new business. This will help you understand when they might be able to start paying again.
5. Increase in deductions, or invalid deductions: One of the most commonly used tactics to delay payments is taking deductions. If you find that a customer is suddenly disputing a lot and most of these deductions turn out to be invalid, watch out. It could indicate evasive customers trying to avoid payments.
6. Spike in orders: A sudden spike in orders could indicate that the customer is stocking its inventory before filing for bankruptcy.
Most importantly, connect and communicate with your customers. While these are the fundamental steps to understand your customer's financial stability and ability to pay, we would love to hear if you have any recommendations.
Robert Shultz · Founder, Quote to Cash Solution