Client Advisor - When It Comes to Troubled Customers, Knowledge is Power
Part One of a Four-Part Series
In this economy, you need to know how to identify a troubled customer. As it becomes more difficult than ever to strike a balance between maximizing sales and minimizing credit exposure, knowing your customers and their situations will help you stay on top of any issues that may arise. Understanding the credit terms extended so you can determine whether the level of risk is acceptable to your company is a necessity. This type of information invariably translates into having a working knowledge of the credit terms afforded to the customer as well as the account history. If the level of risk is not acceptable, identify and implement strategic options which may be available to reduce the amount of exposure.
Start by establishing and monitoring a watch list. It may be impractical to try and keep tabs on all your customers, so consider establishing certain thresholds or trigger points (i.e., significant percentage of sales, amounts outstanding, exceeding established credit limits or remitting payments outside of terms) to determine which customers you want or need to keep a closer eye on. At the top of the list are customers whose downfall could mean a significant adverse impact on your own business operations or finances.
Promote communications between the sales and credit/collections departments. A salesperson’s comments about the reason for a cancelled order, layoffs or equipment start-up problems are valuable indications of potential customer distress. Incentives should be focused on funds collected, not amounts invoiced.
Try to understand the customer’s capital structure (secured or unsecured debt). Identify the stakeholders in the company and whether they “have skin in the game.” Look for warning signs which might include:
- Others are reducing credit
- Slow down in payments
- Exceeding established credit limits
- Customer is being forced to -providing additional collateral
- Checks with old dates – evidence of the customer holding checks
- Customer declines a discount for early payment
- Loan forbearance agreements
- Declining bond prices – if public
- Trading of debt at less than par
- Rating changes – although normally too late
Other warning signs might include defaults on loan covenants, late or no financial statements, or a going concern statement with the audited financial statements. If debt is changing hands at less than par, debt holders may not be as interested in the company’s survival. The retention of a financial advisor to assist the Company in controlling and improving cash flow (a service provided regularly by BMF Advisors), is a sure sign of financial distress. Be proactive and contact the Company and the advisor to request more information.
Get the full picture. To really understand your total exposure, one needs to have a firm grasp of not only current outstanding invoices, but also the account history. Responsible and prudent actions taken to minimize credit risk may create potential exposure to preference claims in the event a customer files bankruptcy. It is important to understand and consider these risks as part of your negotiations with the customer. We will discuss various steps you may want to consider taking to minimize your risks in the case of a bankruptcy in a separate advisory.