Why the old routines for checking your customers’ creditworthiness are no longer helpful.
When cash was flowing and orders were rolling in, businesses were happy to trade with one another on the basis of a sound relationship over the years or, in the case of a new customer, an ear to the grapevine and a few prudent but often cursory checks.
A check with a status agency will soon tell you if a potential trading partner has had trouble meeting its financial obligations, and an all clear from these people would be a green light to sign the sales contract.
Sleepers awake! says Stuart Lawson, head of Aon Trade Credit UK, who argues that in a recession, every business needs to become much more aware of what he calls its debt asset or trade receivable.
Money owing can amount to the greatest part of a company’s market value, so you had better be sure that asset has real, not just paper value. In the past, he says, too many companies failed to understand the profile of this asset sitting on their balance sheet.
He ought to know: he has been in the business for 15 years and has never known the subject of credit protection and receivable management so high on the boardroom agenda.
“Company directors’ minds have been concentrated by seeing what is going on in the economy: inescapable in the automotive, manufacturing or retail sectors and bad enough everywhere else, insolvencies are increasing exponentially,” he says.
“Our own statistics are showing that credit insurance claims are up by around 44% on last year: and the reasons they are going insolvent are very different from what they used to be.”
For that reason, it’s very important that companies get to know their customers from the inside out. “They really need to drill down and have total insight into the profile of their customer base.”
That’s not as easy as it sounds. “The weighting given now to historical financial data is reduced.
"It is no longer a about standing at the front of the ship and looking backwards, it is about making sure you have detailed and recent management accounts so you’re looking at the latest information available.
Anything that goes back more than six months is probably not giving you a true account of the company’s financial strength.”
You need to drill down into three key areas, suggests Lawson.
“Firstly their cashflow – how well they manage their own debt asset in other words; then your customers access to funds – we have seen companies that are financially very strong on paper but if the bank is not supporting that business, it can default overnight; and finally, understanding how their business model is responding to current conditions.
"You cannot simply rely on status information or building an algorithm around certain financial ratios, like net worth or liquidity ratios.”
Lawson admits that 18 months ago, credit insurers were just chasing the business: now the industry has had to respond proactively, and his company has just launched a software package that applies some discipline round the credit management function without requiring a small business to recruit a small army of credit managers.
“You still need credit managers, but this helps them to do the job, which is getting much more demanding as the days go by.”