From CBIA News, January 2003

Clues to creditworthiness

Here’s what to check before extending credit to a potential customer

Few businesses can avoid granting credit to customers — it’s the way 98% of commerce gets done, according to the National Association of Credit Management, based in Columbia, M.D. But hard as it might be to say “no” to a potential customer’s credit request — especially if it’s for a large order — you don’t want to grant credit to a customer who will be unable to pay your invoices on time — or worse, at all.

If your customer is a business, you might want to check the company’s financial statements for clues about its credit-worthiness. These clues, when added to assessments of the customer’s bill-paying record, supply the information you need to decide whether to do business with this customer on any terms except full payment in advance. 

When scouring corporate financial statements, look for these common clues that your potential customer might be a poor credit risk: 

• footnoted liabilities, such as settlements for lawsuits, that aren’t “expenses” by accounting standards and that represent a drag on the company’s liquidity;

• joint ventures, which can also represent unrecognized liabilities;

• sales that are out of sync with inventory, indicating the company could be booking bogus sales;

• receivables that wildly outpace collections — again, a warning sign that the books might be “cooked”;

• a concurrent increase in reported sales and a decrease in the line item of the balance sheet labeled “factors,” which signals that the company could be too readily selling its accounts receivable at a discount; 

• outstanding liens; 

• history of slow debt payment; and

• changes in ownership, management or corporate structure. 

Sidebar: How to improve your company’s credit management