How RFA’s Company Financial Risk Score Challenges the Status Quo

Mark Halstead Risk

A friend who works in insolvency was recently telling me about a case he was working on. 

A London gym was applying for finance to reopen after lockdown. He’d been asked by the gym’s bank to review the business and its loan application.

He found that the gym owners had made revenue projections based on a return to pre-pandemic customer numbers. 

But most of their customers are local office workers. These people now work remotely and the demand for gym membership was likely to be low for some time.  

The world has changed—and so must the way we assess the financial health of businesses.

The UK economy is unrecognisable from what it was two years ago. Factors like Brexit, remote working, supply chain delays, coronavirus support loans and more have all had an impact.

The economic picture is constantly changing and what we used to know about businesses has moved on. With this in mind, it would be madness for credit rating agencies to continue using pre-pandemic scoring methods.

But this is exactly what most of our competitors have been doing. They continue to use outdated scoring models that no longer reflect reality.

In this article, we’re going to look at why using old scoring methods is a problem and explain why Red Flag Alert’s credit ratings are more accurate than competitors. 

Predicting Collapse of P&O Ferries 

As of Thursday 17th March, P&O Ferries have sacked 800 workers  as a result of significant losses of £100 million in 2021. The move has been deemed as necessary by the company in order to make swift changes to survive.

Red Flag Alert's unique insolvency index has plotted the potential demise of P&O ferries for the last 12 months. As of the 2nd of February, 2022, we had scored the business with one red flag with no suggested credit limit, indicating that companies should trade with caution as they present risk factors that might include a deteriorating financial position. As of the 16/03/22, some other credit referencing agencies scored P&O Ferries with a 100 out of 100 rating which indicates very low risk and, a credit limit of £13,000,000. 

Without using Red Flag Alert, businesses who may be owed money by P&O Ferries or who provide services to them, may never have known that the risk even existed, leaving themselves in financial distress to. 

History of P&O Ferries Insolvency Score by Red Flag Alert 

p&o ferries insolvency rating red flag alert

 

Slipping Through the Net: PDR Construction

Some of the industry’s biggest names use scorecards that were designed three years before the pandemic struck.

This puts their customers’ businesses at risk. A good example of this is Yorkshire-based PDR Construction LTD.

PDR was a large UK construction company. In early January, Red Flag Alert rated the business with one red flag, meaning there was an elevated risk of them defaulting on their debts. We also recommended against extending credit to the company. 

Here are the credit limits that three of the UK’s largest credit reference agencies recommended extending to PDR:

  • £1.1 million
  • £435 million
  • £470 million

On Tuesday 11 January 2022, PDR filed for administration. 

The unsecured creditor losses are likely to be very high. Businesses using the three companies listed above to monitor their debtors would have had no idea of the risk that PDR posed. 

Most shocking of all, these three companies' ratings hadn’t changed on 12 January. They were actually recommending a £470 million limit on a company that was in administration!

What Makes Our Company Credit Scores Different?

So why did Red Flag Alert know about this when some of the biggest names in the industry didn’t? 

  • Our data is updated in real-time 24 hours a day 
  • Our scoring algorithm is based on 15 years of insolvency data
  • We’re constantly evolving our algorithm to reflect today’s economy
  • We use data from more sources than our competitors

We’re the only credit referencing agency that constantly changes its scorecard. We analyse trends and use them to recalibrate our scorecards so they reflect the reality of the current economy.

As a result, our credit scores are the most accurate and up to date available. This allows Red Flag Alert users to be proactive and monitor their customers for signs of risk. 

All they need to do is choose the customer businesses they want to monitor and set up alerts for. They will be notified as soon as that customer’s financial position changes. 

This allows them to take proactive measures at the first sign of financial difficulties. This could involve anything from further monitoring to withdrawing credit or calling in invoices. 

Detailed financial ratings

Most of our competitors give companies a credit rating out of 100. This doesn’t indicate whether a company’s financial health will improve or deteriorate. It also doesn’t explain what action they should take.

Our scores are different. Using a sophisticated algorithm, our financial risk monitoring platform rates healthy companies gold, silver and bronze, while companies at risk of insolvency are given one, two and three red flags. We also recommend what action you may wish to take.

Here are two examples from opposite ends of our spectrum:

Gold: A good history of filing compliance, with ideal levels of gearing, optimal liquidity, and favourable trends. Very low risk and open credit is recommended.

Three Red Flags: All the negative characteristics of a business with two red flags, but the situation is so dire that immediate insolvency is probable. 56% of companies with three red flags will cease to trade within seven days. Very high risk and guarantees advised.

Recognised Leaders Providing Credit Scoring to Over 1000 Small Businesses to Enterprise Companies 

Our data and scoring methodology is more advanced than any of our bigger competitors. 

Because of this we’re trusted by organisations that represent thousands of businesses, including:

Greater Manchester Combined Authority (GMCA)

GMCA is a city region home to more than 2.8 million people and has an economy bigger than the whole of Wales.

GMCA’s local enterprise partnership (LEP) supports businesses in the region and helps stimulate its economy.

We provide the LEP with the data they need to make good economic policy and industrial strategy decisions. 

The authority’s growth advisors also use Red Flag Alert when visiting businesses and areas. It helps them identify which areas, businesses or sectors would benefit most from local authority support. 

National Association of Commercial Finance Brokers (NACFB)

NACFB is the UK’s largest trade association that represents commercial finance brokers. For their members, understanding business risk is critical. 

That’s why NACFB has partnered with us, offering all of their members limited free access to Red Flag Alert’s credit scores, data and AML services. 

If you are a NACFB member, sign up to RFA for free today. 

What Goes into RFA’s Scores?

Our database contains over 100 data points on every UK business. Our algorithm uses this information to make accurate predictions. These data points include:

Fixed charges 

Fixed charges ensure that in the event of insolvency, shareholders and company owners are repaid before other debts are settled. Our research shows that companies with fixed charges are three times more likely to end up insolvent.

Accounting period changes

Lengthening and shortening accounting periods is used to avoid filing accounts that reveal the scale of a company’s difficulties. A change in their accounting period can be a sign of trouble.

Liquidity ratios

We use liquidity ratios that discount stock, giving us an accurate indication of a company’s financial position.

Micro-entities

Small businesses are often exempt from filing detailed accounts, making it difficult to gauge their financial position. Our algorithms can create a credit score with very little information. We use data like VAT registration, late account filing and records of bad debt.

London Stock Exchange profit warnings

Every public company failure in the last two years was preceded by at least two profit warnings.

Unadvertised petitions (UAPs)

These are petitions that aren’t published because the company is still being wound up. Our data comes from court records, so it accounts for any legal action taken against a business.

Precise SIC codes

We’ve created 1.4m more specific SIC codes using our AI algorithm. This allows us to accurately identify a company’s industry.

Rapid County Court Judgements (CCJs)

If a company starts getting CCJs filed against it it’s usually a sign of poor management, or suggests that creditors are pursuing unpaid debts. We now update our CCJ records every day.

Direct access to Companies House

Our integration with Companies House allows you to read documents from its register in RFA.

How We Calculate the Financial Health of Businesses 

The Red Flag Alert algorithm uses a range of complex calculations to ensure our credit scores are as accurate as possible. Here are some of the recent developments to our algorithm:

Growth score

It’s important to know which industries, areas and companies have growth potential. The OECD’s definition of a fast-growing company is one that grows at a rate of 1.2X. We use aggregated firm-level microdata to identify which companies meet this criteria.

Most of our competitors only measure growth by a business’s ability to ingest debt—known as the loan propensity score. That means that unless a company has received venture capital or similar investment, it won’t show up in their data. Our competitors overlook a large portion of the UK’s economic growth.

Estimated turnover

Most of our competitors provide estimated turnover based on a company’s current financial statements.

We take this further. By measuring this year's estimated turnover against previous years, we can show which businesses are growing fastest and have the greatest potential for further growth. 

For example, our competitors could tell you that one business has an estimated turnover of £1 million, while for another it’s £3 million. 

The latter might seem like the better investment choice. But what if you found that its estimated turnover had dropped by 10% year-on-year, while the first company had grown 25% year-on-year? Then it would be a different story. 

We make similar calculations for earnings before interest, taxes, depreciation and amortization (EBITDA). 

Real-time dynamic credit scoring

Our data is updated in real-time throughout the day. In contrast, most of our competitors make bulk updates to their data. This means that you won’t know if a customer’s financial position has deteriorated until they decide to make the update, which is one of the reasons our competitors still gave PDR Construction a positive rating the day after it filed for administration.

24/7 real-time updates means you can be proactive, taking action as a result of a change in event, that can be both positive and negative. 

Why You Need Red Flag Alert’s Credit Ratings in the Current Climate

The last two years have been tumultuous for the UK economy. Many sectors are under huge financial pressure. 

Global events continue to exacerbate this. For example, the global supply chain crisis is causing construction projects to be delayed, leading to cash flow issues in the sector.

Many businesses accessed government-backed loan schemes such as CBILS during the pandemic. The Recovery Loan Scheme is the last of these and repayments are due to begin this year. This will put further pressure on struggling businesses. 

With such a fragile economy, you can’t afford to lose key customers and suppliers. It’s critical that you protect your business by monitoring their financial health and taking action early. 

Red Flag Alert’s credit scoring service tells you which companies pose a risk to your business long before a problem arises—rather than when it’s too late.

If you are worried about the financial health of one of your customers and want to see how Red Flag Alert can help, book a demo today. 

 

 

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Mark Halstead Partner

Mark's experience is big data analytics, financial services and building businesses provides Red Flag Alert with strategic direction.