How to Slash Your Credit Exposure

The downturn gives companies an excuse for demanding that customers share more financial information, to keep on top of clients' ability to pay and stay viable.

In particular, trade creditors want to avoid having to return payments received within the 90 days before a customer files for bankruptcy. Bankrupt companies can sue for those payments up to two years after they’ve entered bankruptcy court. So, if a company suspects a client is close to going under, the company can demand cash on delivery, payment in advance of a shipment, or a letter of credit — all of which are methods of payment that are not subject to preference claims.

Another way to avoid unexpected losses: Ask bankrupt customers to add your company to their critical vendor list. Depending on the bankruptcy judge’s ruling, this group of vendors may be paid immediately over other suppliers if the debtor can show that the vendors’ products or services are crucial to the company’s survival and turnaround efforts, notes Marc Hirschfield, a partner at law firm Ropes & Gray.

Getting on Top of Credit Risk

Until recently, when debt became more expensive and harder to come by, companies generally had a blasé attitude toward managing their trade-credit risk. “Most corporations, big and small, don’t have credit risk procedures any more sophisticated than the subprime lenders did,” writes Pam Krank, president of outsourcing company Credit Department Inc., in a recent comment posted to CFO.com.

Krank gives her clients a seemingly simple tip but one that’s been largely ignored until recently: Be more wary before extending credit to new customers. And make them prove their creditworthiness. As it is now, companies take more a of “backward approach” to trade credit by quickly granting it to new clients and then following their pay performance over time, Euler Hermes ACI’s Pontin notes.

Indeed, Krank says, companies too often get in the habit of not asking for any financial information from their customers in favor of speeding up a deal. Suppliers have been doling out credit based on what little information may be available on their privately held clients — despite the fact that private firms have a higher rate of bad debt.Even after an IOU has been granted, the supplying company may shy away from asking for financial data because they don’t want to offend a brand-new client.

Companies should ask for customer and bank references; however, that information may be biased and unreliable as financial institutions struggle nowadays, warns Scott Pales, U.S. country manager for trade-credit insurer Atradius. “Will the bank be there in the long term for their customer? Are they going to provide financing or exit the relationship and leave that company with a liquidity shortfall, which could cause the demise of the company?” are questions Pales says vendors need to ask when looking over a customer’s bank information.

Another way to gain insight into a private company is to attend industry group meetings, Pales recommends. At these meetings — some are held by regional NACM groups — suppliers can hear about other vendors’ experiences with certain customers.

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