Financial industries such as Factoring, Asset Based Lending, and Purchase Order Financing make up a riskier segment of the Commercial Finance business. Companies in this business are always faced with difficult credit decisions. However, lenders are in the business of making these kinds of decisions.
What about your average business today that gets requests from their customers to give them terms? Extending trade credit can be a daunting task when you don’t make your living making those kinds of decisions. Public companies are easy to grab information on and believe you me, you should learn to evaluate public financial statements. It is really the smaller private companies that get you into dangerous territory when it comes to evaluating credit. Companies that look solid at first glance can hide festering problems that eventually can impact your bottom line. Successful risk management requires you to evaluate the financial health of every business that asks for (trade) terms. Here are 6 questions you should be able to answer before extending trade credit:
- Is the business what it claims to be?
Sometimes, companies needing credit will provide inaccurate information to win approval. Before opening an account, you need to confirm the applicant‘s bona fides, including its location, size, number of employees, annual revenue, years of operation and similar financial indicators. Learn to find more sources for this than just Dun and Bradstreet. If you are in a riskier segment of finance such as Receivables Finance (Factoring) or Trade Finance (PO Financing), you may want to pay attention to this advice! - What is its payment history?
Although past performance does not guarantee future results, a company’s payment history is often a strong indicator of how it is likely to behave in the future. Pulling a business’ credit report can easily provide you a snapshot of a company’s payment history as well as other risk measures. Be careful with trade references as you can be sure these trade references have been vetted by your customer. - Are there hidden factors that could affect its ability to pay?
Are there pending judgments, lawsuits, bankruptcies, regulatory citations or other “red flags” that could make it difficult for the applicant to meet its obligations in the future? This is another area where a business’ credit report will be a key factor in helping you uncover a potentially risky business. You can also use a background reporting agency such as TLO to get vital information here. - How much credit should you extend?
All credit contains an element of risk, but you can mitigate that risk by limiting the amount of credit you extend based on factors such as the customer concentration, sales volume, debt to-asset ratio and similar aspects. Overall credit should be considered as well. In the case of Factoring companies or Commercial Banks, the overall credit limit is driven by these factors. - Under what terms should you extend credit to this customer?
You can mitigate risk further by carefully calibrating the combination of interest rates, minimum payments and other contract terms based on each customer’s individual financial metrics. - Are they performing?
Once you have extended trade credit, you should not go to sleep. Monitor their payment performance carefully, and do not be timid in discussing any issues with your customer.
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Mr. Cox is Managing Principal with Pendleton Capital Group, Inc. – a Factoring and Trade Financing company headquartered in Houston, TX. PCG provides professional “best practices” Factoring and Trade Financing and other small business services. His office is in Houston, TX, and he can be reached for additional information or consultation at adam@pendletoncapitalgroup.com or 713-808-9746. The company’s website can be accessed at www.pendletoncapitalgroup.com
