Non-Financial warnings signs. (Business Credit Selected Topic).(Brief Article)

With 80 percent of North American companies being privately held, financial information is often not available, and credit grantors must rely on non-financial information in order to make their credit decisions. Without the use of financial parameters or ratios, how can these professionals evaluate the solvency of their customers? In this article, we will present some non-financial indicators of financial problems, which when detected early can lead to a happy ending for all concerned. These indicators fall into the following categories: Payment Patterns, Purchasing Patterns, Industry Trends, New Developments, Lawsuits, Personal Problems and the Rumor Mill.

Payment Patterns

Companies typically pay invoices on a regular, albeit sometimes tardy basis. Any change in this pattern should be a red flag to creditors and could be an indicator of financial and cash flow problems. These changes include a company no longer taking advantage of discount terms or a company extending its payment terms. For example, in the fall of 1996, privately held T. Eaton Company Ltd. extended its standard 75-day payment terms. The company filed for protection under the Canadian Companies Arrangement Act ("CCAA") in February 1997.

Purchasing Patterns

Are your customers' orders increasing or decreasing? A decrease in purchases may indicate that a customer's sales are declining or that the customer has found another supplier. If a customer has reached its credit limit, and the account is overdue, a decrease in purchases may suggest that the customer is unable to meet its liabilities and is unfortunately increasing its credit by purchasing from another supplier. Is your customer purchasing a higher number of smaller orders? This could indicate that a customer does not have sufficient cash flow to pay for larger orders. A sudden increase in purchases is also suspicious if there is no evidence that the customer is experiencing an increase in business. Maybe the customer is stockpiling inventory prior to a court restructuring.

Industry Trends

What are the industry trends and how do they affect your customer? Have technological advances negatively impacted your customer? Is your customer in danger of losing market share due to new technology? Are your customers adversely impacted by changes in the industry or the economy in general? For instance, the auto industry is one of the primary customers of the steel mills. A downturn in automotive sales will impact not only the automotive industry but will have a domino effect on their suppliers whether they are original equipment manufacturers, the second tier suppliers, the aftermarket manufacturers or businesses in the surrounding areas.