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How To Assess Your Customers’ Financial Health

Sep 25, 2019 Red Flag Alert Updated On: September 26, 2023
How To Assess Your Customers’ Financial Health

Assessing your customers’ financial health is vital to ensuring the security of your business, but time constraints and a limited understanding of company accounts can make this challenging for the average business owner.

The information that is readily available from sources like Companies House can provide you with some good indications of potential issues – providing you know what to look for.

However, this information needs to be viewed in the context of a company’s situation, the market it operates in, and the way that it does business, in order to draw reliable conclusions and make sound business decisions. There are still reasons to trade with financially distressed businesses which revolve around favourable trading terms.

In this article, we’re going to look at some basic company credit checks which you can make using readily available data and some of the things which you may need to consider during this analysis.

We’ll then take this to the next level, looking at how big data can help you to accurately predict the direction of travel when it comes to your customers’ financial health.

Health Indicators for Informed Assessments

Not only is doing your own credit check time consuming, but it can also be difficult to draw accurate conclusions from publicly available accounts. Many companies attempt to hide poor financial performance using a range of techniques that, on paper, make them seem financially healthy.

However, some form of assessment of your customers’ financial health is better than none, and luckily there are several important indicators which will give you a more informed picture. Let’s look at a few.

Look Out for Fixed Charges

If the owners have a fixed charge over company assets, it means they get paid first in the event of insolvency. This phenomenon happens a lot in private equity: investors finance the business but place a charge over the assets.

If the owners are protected in the event of failure, then they may run the business differently – perhaps they will even take more risks.

Our initial research suggests a business where directors/shareholders have a charge over assets are 2.8 times more likely to fail.

Have They Accrued Losses as an Unsecured Creditor?

Being an unsecured creditor in an insolvency procedure can be devastating for a business – most trade creditors receive less than 10% of the money they’re owed.

Being an unsecured trade creditor in insolvency leaves a company three times more likely to fail, but the level of risk is variable.

Data on companies that face bad debt is available, but needs to be placed into context. The size of bad debt relative to net worth and incidents of bad debt will give a better indication of the likely effect.

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Beware Late Accounting or Charges in Accounting Periods

Overdue accounts or a change in a filing period are clear indicators that a company is in trouble. It may indicate a business is poorly managed and doesn’t have the procedures in place to meet statutory obligations.

Overdue accounts can also delay obtaining a view on the financial health of a company. Repetitive accounting period adjustments are a common feature in the history of failed companies.

Check the Book Value of Assets

It’s common for the book value of assets to evaporate in insolvency. In the recent Jamie’s Italian insolvency, £29.9 million of assets subject to a floating charge were expected to realise only £400,000.

Goodwill can be grossly overstated; often a company will acquire a business at a high price and then be unable to generate value from the business. The acquisition price is stated on the balance sheet, but the business may be worth many times less.

Other assets that are often not worth book value are debtors, stock, and even tangible assets like plants and machinery.

Read the Terms and Conditions for Liabilities

Businesses may have signed loans on poor terms that could have severe consequences if repayments are missed.

With some loans, you don’t even need to miss repayments to incur penalties. If a property has been used as security but reduces in value (not uncommon for commercial property), this can trigger penalties.

Check the charges that creditors have over the assets of the business – if repayments are missed, assets may be at risk.

Assess Liquidity

Poor liquidity can lead to a constant need to plug holes in cash flow, which is expensive, time-consuming, and often fatal for a business.

The ‘current ratio’ looks at a company’s ability to meet short-term obligations, and the ‘quick ratio’ does this by discounting stock.

Different industries will have different levels for what constitutes a good ratio. Take restaurants, for example – data from Macrotrends points to the average restaurant current ratio being 1.1.

The key question is: are you comfortable that the business can weather the storm if there is a problem with cash flow, such as a downturn in revenues or a big outlay?

Be Wary of Low Margins

Businesses working on low margins often have little room to manoeuvre when hit by an unexpected missed payment. Problems may be compounded if the company struggles with other issues such as bad-debt making up a high proportion of overall revenue.

Low margins should prompt further investigation.

Low margins should prompt further investigation.

The methods described above are good initial indicators of a company’s financial health; however, they only provide a snapshot of whenever accounts were last filed and, of course, require some time-consuming analysis. It’s far better to use real-time information and large datasets. 

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Take a look at the latest trends and data affecting the UK Economy

At Red Flag Alert, we use multiple sources to gather 100+ data points on each of the UK’s 6.5 million businesses. We make 100,000 data updates every day and offer a view of the country’s business landscape that is unmatched in its breadth and depth.

Over 13 years of learning has allowed us to develop complex algorithms that put business events into context. This means that every financial health rating is supported by millions of data points and a decade of data. If a CCJ of a certain size normally leads to failure in a certain sector, our algorithm picks that up and calculates the company health rating accordingly.

This means that we can accurately assess the risk implications which your customers may present, even though the information available is limited.

This enables you to make informed and reliable decisions and helps make your business secure and sustainable.

To talk to one of our team about how Red Flag Alert can protect your business from risk, book a demo today. 

Published by Red Flag Alert September 25, 2019

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