As trading continues to be challenging for UK businesses, now is a perfect time to start reviewing how you monitor the creditworthiness of your customers. Carillion, Gaucho, Toys R Us and Maplin are high-profile names that have entered administration, and the trend looks set to continue. The government’s Insolvency Service reports states that “the underlying number of insolvencies increased in Q1 2018, to the highest level since Q1 2017”. Research conducted using Red Flag Alert’s data set identifies that at the end of June 2018, 472,183 UK businesses were experiencing ‘Significant’ financial distress, up 9% compared to the same stage last year.
Many companies purport to offer company credit checks but, as with everything, the variability in quality is considerable. Red Flag Alert has been developed over the past 15 years to provide a robust process by which you can perform credit checks. This guide explains how Red Flag Alert works, so you can understand what our credit scores mean.
Company Credit Checks are Complicated
The credit score of a business is based on many factors, including their sector, financial information, management, economic outlook, distress events and many other issues. No credit score can incorporate every factor, but you need to make sure you cover certain key points.
Businesses in obvious financial distress are pretty easy to spot – a history of company CCJs, poor financial records, and a large amount of increasing debt are all signs that a business may be a risk. What is harder to spot is when a business is teetering between stable and unstable or when a business looks stable, but a closer look uncovers problems.
A sophisticated algorithm is crucial because of the complex data being assessed; a good company credit report will focus on the key information and then draw conclusions which are highly specific.
A company credit checking system should give information that will help to guide your business decision-making and allow you to take pre-emptive steps if one of your customers is having financial difficulties. At Red Flag Alert we focus on a granular, flag-based system, which not only indicates distress, but also shows its level of severity.
· One Red Flag = 30% of businesses fall into insolvency within 30 months (Assurances and perhaps guarantees advised)
· Two Red Flags = 50% of businesses fall into insolvency within 12 months (Guarantees advised)
· Three Red Flags = 60% of businesses fall into insolvency within seven days (Cash with order)
Carillion indicated two red flags for 12 months prior to their insolvency. Any supplier with this information could have mitigated their risk - hopefully saving many from insolvency.
We have spent considerable time building this view of risk that indicates when a company may be starting to have financial issues. This is essential in responsible customer monitoring because you can see when problems are brewing. Many company credit checks simply tell you when the problem has arrived. This is too late as you need to see issues coming, and at Red Flag Alert our model focuses on that. You can read more about how we work here.
What Factors Are Reviewed in a Company Credit Check?
At Red Flag Alert we use a highly evolved algorithm to reach conclusions based on many data points and built on three different scoring models: judgemental, statistical and blended.
Judgemental Scoring Model: This looks at the key fundamental factors, audit reports, the presence of CCJs, age of the business, etc. These are the elements that allow us to start building a picture of the credit rating.
Statistical Scoring Models: These models weight different factors based on a range of criteria and build a picture of the likelihood of financial distress by ensuring that the most important factors for a particular business are factored in.
Blended Scorecards: This is typically a statistical model with judgemental factors running a set of rule-based overrides – incorporating the best of both worlds!
Scorecard Development Never Stops
At Red Flag Alert our team focuses obsessively on scorecard development, because sophisticated scorecards will ultimately lead to accurate company credit reports. We are always evolving our model so the most leveraged factors are built into the scorecard, and over 15 years we’ve increased our accuracy and have cemented our position as the UK market leader.
What Data is Included
The core attributes we include in our scorecards differ for incorporated and unincorporated businesses. Let’s take a look at some of the key factors for limited companies.
Age since incorporation: This isn’t a highly significant factor, but has some statistical importance. The risk between a business that has five years of trading versus one with twelve years is material.
Age of latest accounts: Unsurprisingly, lateness of filing accounts is an indicator of distress. Our data has shown that late filing of accounts is a good indicator of a company that is poorly run and signifies an increased risk of future financial distress.
Cash on the balance sheet: This can give some indication – a specific focus on the trend over time and other current assets on the balance sheet gives useful additional context.
P&L account reserve: Generally less important than cash issues but, unsurprisingly, profitable companies are generally a lower risk than loss-making ones.
Shareholders’ Funds: Looking at the trend over time can be indicative of upcoming financial problems.
Liquidity Ratio: Unsurprisingly this ratio is an important factor to predict future insolvency. What constitutes a bad ratio will vary from sector to sector, this context is critical when making judgements.
Shareholders’ Funds total asset ratio: This helps us determine how the business is funded. Often a high proportion of loan capital indicates an elevated risk.
County Court Judgements: These need to be contextualised by considering the judgement versus the size of the business and value of the CCJ. The number and the timing of judgements is also important. In certain circumstances, CCJs may not be a good indicator of insolvency.
Audit Conclusions: Although often not indicative of issues due to being opaque, sometimes specific comments on an audit can be important.
Worried about the creditworthiness of your customers?
Our Red Flag Alert software collects, analyses, and reports on the credit risk of every business in the UK. We use information from ten leading data providers and enrich it with our sophisticated scorecards to give you a specific score on every business.
This quality and depth of data is only available through Red Flag Alert. You can even plug the data directly into your CRM using our API, so if risks materialise for your customers you’ll have the detailed information you need immediately.
For a free client health check consultation using Red Flag Alert, please get in contact with Richard West on firstname.lastname@example.org or 0344 412 6699.