Cash Management

Ten Signs Your Customer Is Tanking

When it comes to credit risk, watch closely for these red flags in companies you depend on.
Sarah JohnsonJanuary 22, 2009

The shaky credit markets make spotting a soon-to-be insolvent company increasingly difficult for credit managers. “It’s hard sometimes to determine who’s really about ready to go out of business, versus who is having tough times, but they’ll make it,” says David Beckel, president of the National Association of Credit Management.

To avoid losing future payments, companies should be on the constant lookout for red flags — signs that a customer is having serious financial problems. The following don’t necessarily indicate that a client is in contingency mode. But any of them should trigger a warning bell for your credit department that the customer deserves close monitoring, and that perhaps their payment terms renegotiated.

Changing Payment Patterns. Perhaps the most obvious clue that something could be financially amiss, but one that cannot be ignored, particularly these days. Previously reliable customers that suddenly start missing due dates warrant attention: “If your customer is falling further and further behind in making payments on their invoices, that certainly should be a tipoff that something may not be right,” notes Marc Hirschfield, a partner at law firm Ropes & Gray. Renegotiation requests — say, if a company asks to spread payment windows from 30 days to 45 or 60 days — should raise eyebrows. Hone your credit skepticism on requests to reschedule payment agreements, such as paying off one service over four months rather than all at once, as previously agreed upon.

Shifty Buying Habits. Even if regular customers are paying on time, are they still purchasing? If their previous buying was consistent, but their manner of placing orders has changed, this could suggest trouble. Also keep lookout for regular customers that suddenly start buying more. Pre-bankrupt companies have been known to stock up on inventory, knowing they won’t be liable for the goods later on, Hirschfield notes.

Constant Nitpicking or Higher Demands. Is a customer you once barely heard a peep from now returning items more often, or unjustifiably asking you to make deductions off invoices because of damages? Customers that start making unreasonable demands on delivery could be sending you a warning, saysScott Pales, U.S. country manager for trade credit insurer Atradius. A customer, for example, may start saying his company expects a discount if a shipment doesn’t arrive in a certain amount of time that you can barely meet. Look out.

Shrinking Cash Flow. Keep watching your customers’ cash balances over time, if you have access to their financial statements. Find out how much they rely on equity, short-term debt, or long-term debt, Atradius recommends.

Large Accruals. Many distressed companies carry sizable accruals on their balance sheets, so these figures need to be explored and justified, suggests Atradius.

Tight Lips. Customers that previously shared financials with your company, but now suddenly claim it’s against their policy to share financial data, could be “a pretty big red herring” that could distract you from catching problems, Pales says.

High DSO (Days Sales Outstanding). Companies that have fallen behind on collecting their own receivables may be unable to contribute to yours.

Managerial Shuffling. Changes in management could mean that there’s a disagreement between executives and the company’s board or owner, Hirschfield advises. More obvious signs of trouble in this regard would be the hiring of a chief restructuring officer or turnaround company.

Persistent Rumors. Credit experts recommend keeping your ears open for any negative news about your customers, which may be the only way to garner helpful financial information about privately held clients. Pay attention to news articles, whispers from your sales teams, and other companies’ credit managers. NACM has industry-specific credit groups that are invaluable for uncovering past-payment records of customers, Beckel says.

Tax Liens. Pam Krank, president of outsourcing company Credit Department Inc., says a tax lien against a company is the number-one indicator that it’s going under. If a customer has postponed paying its state and federal taxes, you’re not likely to see its overdue payments either.