Risk Management

Credit Check

One in seven midcap companies may be a credit risk. Are any of them tied to you?
Scott LeibsOctober 1, 2009

Editor’s Note: For a look at how three dozen industries are faring on key metrics associated with timely payment of invoices, check out the 2009 Credit Risk Benchmarking Report

“Credit is pretty simple,” says Barbara Smith, CFO of Gerdau Ameristeel. “If you have a set of good policies, and have a good process for adhering to them, and good people, you’ll be OK.”

Anything else? “Metrics,” she adds. “Metrics are key.”

Smith is the finance chief for North America’s second largest minimill steel producer (with $8.5 billion in revenues), and she readily admits that her company is keeping a closer eye on customers. “We know from past experience which segments will be hit hardest,” she says, “and we know that smaller companies will face more credit issues.”

But watchfulness, she adds, can make a huge difference. “We’ve had customers go into distress, but by the time they became insolvent our exposure had become minimal.”

When Smith talks about metrics, she’s talking about a wide range of measures, including internal benchmarks such as the commercial side’s ability to collect. “They may take more risks,” she says, “unless they have incentives to make sure invoices can be collected.”

Smith’s team also looks at some fairly straightforward measures, such as how long customers are taking to pay. “If you know that a reliable customer is now 10 or 20 days late, you know there’s trouble,” she says.

Image promoting CFO's Credit Risk Benchmarking Reports

Indeed, days payable outstanding — and, equally important, a company’s DPO relative to the payment performance of its own industry — is a key component of CFO’s Credit Risk Benchmark. Intended to help companies spot potential trouble, the benchmark showed that approximately one in seven midcap companies across nearly three dozen industries poses a potential credit risk to its suppliers.

That number varies by industry, with the highest percentages of troubled companies appearing in the pharmaceuticals (46%), biotech (35%), and media (26%) industries.

Pam Krank, president of Credit Department, an accounts-receivable consulting and outsourcing firm, says CFOs are “finally putting credit risk at the top of their lists” for the first time in her 18-plus years in business.

Many companies have devoted substantially more rigor to assessing the financial health of both their suppliers and their customers. Corning, for example, now looks at a host of metrics for its suppliers, ranging from working capital to return on equity. And if it can’t find the data it needs publicly, it calls the supplier and asks, then builds short-term projections of the supplier’s financial health.

As for assessing customers’ ability to pay, one CFO says he now requires his staff to refresh the credit file for any customer that hasn’t ordered in the past six months. With no recent payment history to go by, he says, he has to go to greater lengths to assure creditworthiness, including checking trade references and flagging any customer that is more than five days late with a payment.

In the immediate aftermath of the Lehman meltdown, weeks-old financial reports proved all but useless as a gauge of immediate creditworthiness, World Fuel Services CFO Ira Birns told an audience at the CFO Core Concerns conference in June. A year later, however, publicly reported payables and cash performance can be a useful indicator of which companies are holding their own, and which have begun to slip.

We offer this snapshot as a way to see at a glance how the industry or industries that you deal with most often may be faring. As the box below indicates, more-detailed data is also available on our Website.

About the 2009 Credit Risk Benchmarking Report

The Credit Risk Benchmarking Report is intended to provide, at a glance, an assessment of the overall credit health of approximately three dozen industries. We looked at Q2 2009 data for more than 550 companies within the CFO Midcap 1500 (companies with annual revenues from $100 million to $1 billion) to see what percentage of companies within each industry may be potential credit risks.

We measured individual companies on two simple and relatively common factors: cash as a percent of revenue and days payable outstanding (DPO). Then, for each industry, we reported which percentage of companies had deteriorating performance for those two benchmarks. We then assigned a red or a green light for each benchmark in each industry based on the aggregate performance of the companies in that industry for that particular benchmark.

For the first benchmark, we used change in cash as a percent of revenue because companies that demonstrate significant reductions in cash as a percent of revenue may be struggling to make ends meet and may pose a credit risk.

To calculate the second benchmark, DPO, CFO Financial Benchmarks used the same methodology that CFO magazine uses in the annual CFO/REL Working Capital Scorecard: Quarter-end trade payables divided by one day of average revenue. A sudden lengthening of DPO can be considered a sign of financial distress. For purposes here, a DPO that is longer than the same period in the prior year receives a red light, while a DPO that is the same or shorter receives a green light. (Note: Many companies use cost of goods sold instead of revenue when calculating DPO. Our methodology uses revenue because it allows a balanced comparison across industries.)
Click here to view the 2009 Credit Risk Benchmarking Report.