Insights & Reports > Business Intelligence: Don’t fly blind

As this severe global recession unfolds, few business certainties remain. One that does, though, is that all companies need good, reliable customers in order to survive. Amid the worrying economic statistics in the daily headlines, the breaking news that CEOs least like to read over their breakfast cereal is that a key customer has suddenly gone bankrupt. Companies are therefore monitoring the financial health of their customers, especially those to which they have extended credit, more closely than ever before.

When a customer suddenly goes bankrupt, the chance of recovering any credit that you have provided is very slim. This one-off financial hit, though, is not the only problem you will face. If the client is a significant one, your business plan is put into a spin; your forecast revenue must be reduced, at least over the short term; and you may not achieve your quarterly performance target. Therefore, with things already tight, and your shareholders jumpy, you need to do two things fast: check the stability of your existing customers, and accelerate the search for new ones.

While the importance of understanding a customer’s financial stability is well understood, it is a difficult exercise at any time, and particularly so during a deep recession. As companies struggle to get by, frequently living from month-to-month, they are not inclined to tell their suppliers – who are both key to their survival and also, often, a source of credit – about any trouble until they lose the battle and go under. You cannot afford to be put off by these challenges and risk being caught out.

In March 2009, 7,843 commercial bankruptcy filings were made by U.S. companies – a number which exceeds February 2009 filings by 23%. Businesses in Europe are also suffering. In December 2008 the number of corporate bankruptcies in Germany rose for the first time in five years. 30,000 German companies declared bankruptcy in 2008 and experts have predicted that this number could rise to as much as 35,000 in 2009 which would mark a 17% increase. The retail and auto industries in Germany have recently seen a number of high- profile bankruptcy cases, with companies such as Woolworth Germany and Karmann filing for bankruptcy in 2009.

In December 2008, U.S. toy company KB Toys filed for Chapter 11. Many Asian factories were supplying KB Toys through buying agent Li & Fung, was issuing the letters of credit. The bankruptcy of KB Toys left Li & Fung with unpaid commissions, and facing legal action from the factories for not honoring the letters of credit. The factories themselves had no idea about the dire financial situation of KB Toys in the months leading up to its bankruptcy, and felt that Li & Fung should have been better informed about KB Toys’ true financial health.

Determining the true state of a customer’s stability is a multi-step process. Most obviously you need to maintain a regular dialogue with them, asking direct questions about their financial health and, more broadly, about the business environment in their sector and their country. You should also be alert to, and question, changes in their behavior. Customers approaching bankruptcy are likely to be slower in paying their bills and to ask for more favorable credit terms, both of which can gradually raise your financial exposure to dangerous levels.

If conversations with your customer leave you in doubt, or you see worrying patterns of behavior emerge, it is time to conduct a review of the public record. This can include ordering a standard online “credit check,” but you must never rely on this alone. The fact that businesses exist, to help companies correct faults in their credit reports, shows the latter’s limitations. Particularly important in the current environment, credit check data is historical. It will rarely include information on any new crisis that your customer may be facing.

For comprehensive public record research, conduct regular database sweeps to detect issues such as corporate restructuring, urgent fund-raising, payment disputes with other business partners, and bankruptcy of other group companies. Online media research can tell you how the recession is affecting your business partners’ market segment in their country. The public record can also be used to investigate specific concerns that have arisen, or market rumors that you may have heard. Talk such as “the PE firm that owns them is urgently looking for a buyer,” or “their auditors have resigned,” should be obvious red flags that need investigation.

Public record research is important, and can sometime be sufficient for you to make the decisions you need about customers, but this is not always the case. Large corporate bankruptcies continue to catch the business community by surprise. An extra level of research is available for your most important clients.

This third step is to conduct human source inquiries in the customer’s locale in order to find any undisclosed or unpublished issues. The best way to know if a company on the other side of the world is truly stable is to speak to a range of business sources with direct access to it. These sources can provide reliable insights into the company’s current reputation and the circumstances of its own customers, business partners, and competitors. This research can be conducted quickly and discreetly, so that your customers will never know that you have been diligently verifying their claims of financial health.

If any of the above inquires leave you concerned about a customer’s stability, but you do not want to terminate the relationship, you can take several steps. Shortening payment terms is good; pre- payment or cash on delivery is even better.

Ensuring that ownership of inventory and intellectual property is clearly defined is also sensible, as this prevents unnecessary disputes should bankruptcy occur.

Careful monitoring of customers will help you to decide when to extend them credit, when to insist on new payment terms, and when to start looking for replacements. With all the difficult work you are doing to restructure your own business and operations in order to prepare it for the coming year, you cannot afford to let your company to be ruined by someone else’s sudden failure.

Summary	The damage caused by key customers going bankrupt is immense, especially in difficult economic times. Companies should engage in regular dialogue with clients about their financial situation; review relevant public information; and, where appropriate, have discreet conversations with those who know the customer best. Awareness that a client’s finances are rocky does not necessarily mean abandoning the relationship, but with it companies can shield themselves if the worst occurs.
Research on customers will take between 1 – 3 weeks.	FVAs generally take 4 - 6 weeks to complete based on the size, geographic location(s) andnumber of facilities.
Cost considerations	Costs range from several hundred US$ per customer to several thousand, depending on volume and depth of checks.
Advantages	Knowing which customers are weak, which are strong, and why, is essential when developing your business plans.
Risks	Substantial if your largest customer goes bankrupt while owing you payment.

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Jack Clode is a Managing Director in Hong Kong and can be contacted on +852 2884 7788 or .