With the exception of losses experienced by trade creditors in some high-risk industries like retail, restaurants, and energy, creditors have indeed been fortunate in minimizing bad debt and maximizing cash flow from trade receivables portfolios since the Great Recession of 2008. Much of this success can be attributed to cheap, easy debt and strong economic growth which have allowed lower credit quality customers to pay creditors within terms and avoid insolvency.
Reduction in Corporate Profitability
In the United States, non-financial companies are reporting declines in quarterly profits for the first time in more than a decade since the 2008 recession (Valetkevitch, 2019). The reduction in profitability is caused by a number of corporate challenges including: rising labor costs, tariffs and increasing short term interest rates. As the demand for a higher minimum wage becomes prevalent within the working class, rising wages affect labor costs. The unpredictability of tariffs is also resulting in unintended consequences to supply chain costs. The fall season of 2019 saw short-term interest rates that were a tenth of a percentage point higher than in the summer of 2019. After two consecutive quarters of declining profits, US companies will experience an “earnings recession.” (Economist, 2019).
The earnings recession has alerted analysts to see profit margins shrinking by 1.1 percentage points, the first year-over-year decline in at least two years”
Credit managers must be measuring profitability and cash flow of their customers NOW to understand risk factors increasing the odds of customer default. Businesses don’t generally run out of money quickly; deterioration happens over several reporting periods.
Record High Debt loads
The US already has a debt that is close to 110 percent of its GDP – $22 trillion. The deficit is running close to 4.5 percent of the GDP; this number should not exceed 3.0. The US has no surplus to draw from should there be a recession so any spending or tax cuts will simply add to an already staggering debt load. Many nations are in the same predicament which makes reacting to a global recession even more difficult.
Just as with governments, corporations have loaded up on inexpensive debt to fund their growth needs. Creditors are seeing these heavy debt obligations in their customers’ balance sheets: U.S. corporations are sitting on nearly $10 trillion dollars in debt. That is equivalent to 47 percent of the economy, a new record. It will eventually come due. Some of these heavily indebted companies are filing for bankruptcy in an attempt to convert debt to equity and stay afloat. At the very least, this existing debt is making companies extremely vulnerable to a downturn. It’s estimated that if a new downturn is half as severe as the 2008 recession, corporate debt-at-risk could increase to $19 trillion. It’s also noted that the recent increase in corporate debt has mostly been acquired by companies at highest risk of default. According to the Federal Reserve, the ratio of debt to assets for all publicly traded, nonfinancial companies has hit its highest level in two decades, and the leverage ratio among debt-heavy firms is near a historical high.
Credit Departments should be segmenting their highly leveraged customers to watch for changes in cash availability to ensure proper adjustments to these customers’ unsecured credit lines and to create security agreements where possible. In portfolios where most customers are privately held, updated bank references will be critical to this assessment.
Slowing Growth Worldwide
The World Bank sees U.S. growth stumbling from the unspectacular 2.3 percent growth in 2019 to 1.8 percent in 2020 and only 1.7 percent in both 2021 and 2022. That would be nearly the lowest annual rate since the last recession ended in mid-2009. At the American Economic Association’s annual meeting in early January, 2020, Economists “warned one another about [Trump’s] trade war, about government budget deficits and, repeatedly, about the inability of central banks to fully combat another recession should one sweep the globe anytime soon,” they write. “Underlying their sense of foreboding was a widespread sentiment that the current expansion is built on a potentially shaky combination of high deficits and low interest rates — and when it ends, as it is bound to do eventually, it could do so painfully.” Companies planning to grow their way out of their debt obligations and challenging profit environment will have a difficult time executing this strategy during this extremely slow growth period.
Credit Departments cannot lose their focus on containing threats to the quality of their trade receivables portfolios by relying on their past performance. They must be closely studying customer financial trends while monitoring outside data and internal payment detail to understand how to focus their efforts on those customer balances most at risk for payment slowness and defaults. The warning signs are there; Credit must heed them now to prepare for an unpredictable and challenging 2020.
- “Profits Are down in America Inc.” The Economist, The Economist Newspaper, Valetkevitch, Caroline.
- “For First Time in a Decade, U.S. Companies Could Report Lower Profits on Higher Revenue.” Reuters, Thomson Reuters