I’ve had a number of conversations with financial people who are fearful about asking their customers for financial information. They’re afraid of the responses back from the customers: “Why do you need this information?” “What will you be doing with it?”
Credit Managers need to remind the customers that they’re providing hundreds of thousands, even millions of dollars of unsecured credit to them without understanding the probability they’ll be paid on time or at all. In exchange for a large credit line, the credit manager is owed financials to justify the line.
Typically, credit managers’ only inkling of future payment ability is by reviewing credit reports and internal payment records–ie, how the company has performed in the past. How many banks could you walk into and get $500,000 credit without showing them financials? None! This practice, though, is common for trade or commercial credit analysis.
There are only two reasons for customers to be reluctant about sharing financials: 1) They don’t trust what you’re doing with the information and/or 2) The information won’t have a positive effect on your relationship with them.
To alleviate the fear that you’ll do something nasty with their financials (like showing them to your sales managers or posting on the Internet), provide customers with a confidentiality agreement. This will give them some sense of trust that only your credit department will be looking at them — and no one else. Also, tell them exactly why you need it (ie, your credit line has exceeded the maximum amount we can give to a customer without financials).
If the customer is afraid you’ll see things they don’t want you to see, you should at least get basic information to help you make a decision. Many companies won’t share their P&Ls (for fear suppliers will think they make too much money and will raise prices accordingly) but will hand over balance sheets. Great — take them! Always ask for balance sheets, income statements, and cashflow statements. If we only get partials, we then model the remaining part of the statements to measure changes in financial performance. That’s one of the biggest keys to analyzing risk: comparing the condition of the company from period to period.
When you only have the choice of one statement, I’d choose the cashflow statements (bank reference will give you cash asset totals from the balance sheet). After all, companies don’t default because they run out of sales or assets. They fail to pay you because they run out of cash.
If you want to accurately assess the risk of default of your customers, you need to analyze financial performance. Don’t be afraid to approach your customers for the information. Sign confidentiality agreements, meet them in their office or obtain partial financials over the phone to get what you can to make informed decisions. The more information you have about the customer, the better the credit underwriting decision.
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