Conducting proper credit checks and analysis before starting a new business relationship can save a lot of pain further down the track. The upfront cost of doing more than the most basic checks can seem like a luxury, but a few market observations suggest smaller businesses are exposed to greater risk when extending credit.

According to the latest full year figures available from ASIC, at least 78.9% of all commercial insolvencies in FY2017 were businesses with less than 20 employees.

 The point at which a company enters external administration is a lagging indicator and often far too late for unsecured creditors, who are dangerously exposed to being hung out to dry. In more than 35% of all external administrations, the business entity was found to have traded while insolvent for more than two years prior to an administrator being appointed.

 The same 2017 ASIC data revealed in 96.3% of cases, unsecured creditors recovered less than 11 cents in the dollar.

 The top causes for business failure were ‘inadequate cash flow’ and ‘poor strategic management of business’. Administrators will look at various indicators to determine if company directors had reasonable grounds to suspect insolvency. These include:

  • Financial statements that disclose a history of serious shortage of working capital, unprofitable trading
  • Poor or deteriorating cash flow or evidence of dishonoured payments
  • Difficulties paying debts when they fell due (e.g. evidenced by letters of demand, recovery proceedings, increasing age of accounts payable)
  • Non-payment of statutory debts (e.g. PAYGW, SGC, GST)
  • Poor or deteriorating working capital
  • Increasing difficulties collecting debts
  • Overdraft and/or other finance facilities at their limit
  • Evidence of creditors attempting to obtain payment of outstanding debts

To stay ahead of the game, sophisticated businesses are monitoring indicators such as these before a business fails.

In the current data rich environment there are multiple data combinations available to provide useful insights to businesses seeking enhanced risk assessment. A sudden deterioration of payment behaviour is one of the leading indicators of business failure, and it becomes much more powerful when combined with industry analysis, location data, financial statements and other signal intelligence.

These forms of due diligence have become de rigeur among large corporations. Given their increasing availability, and the cost benefits they provide, there is no excuse for smaller businesses failing to use similar checks and monitoring tools.

At the most basic level, there are a few simple questions every business owner should ask before extending credit to a new supplier or customer: Are other companies currently attempting to recover an outstanding debt from this business? Are overdraft and other finance facilities reaching or at their limits? Does the business have sufficient working capital, healthy cash flow and a history of trading profitably? Again, one of these on its own may be concerning, but a combination of these factors can amount to a serious red flag for your credit assessment protocols.

These represent the most basic checks, however, and savvy businesses know that regular tracking and reviewing of client portfolios is the best way to protect against over extending credit in risky areas. Curated and properly analysed client portfolios deliver security, balance and enable strategic business management in the short, medium and long-term.

Sharon Sheather

Managing Director, Corporate

October 2018

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