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Recognising credit risk is central to business survival: Veda

The current economic climate is putting increased pressure on Australian SMEs and causing more to enter external administration, according to new research from Veda.

Veda research has found the number of companies entering external administration in the April to June 2011 quarter increased 6.3 percent on the June 2010 quarter and 19.6 percent on the June 2008 quarter, which was during the height of the first GFC.

Veda’s head of Commercial Risk Moses Samaha said, “Concern over a possible global credit crisis, reduced consumer sentiment and delays in customer payments are no doubt adding strain to business cash flow. Tighter financial and credit management practices will now prove vital for SMEs to avoid the risk of insolvency over the coming 12 months.”

At 19.8 percent, the construction industry accounted for the largest proportion of those entering external administration. Not far behind construction was manufacturing (13.9 percent), retail trade (8.8 percent) and professional, scientific and technical services (8.3 percent).

Mining, information and media, and education and training accounted for the least amount of external administrations at 0.7 percent.

“Ignoring the signs of a problem customer or supplier could be the difference between collapse and survival,” Samaha said.

Veda recommends businesses adopt the 5C’s of credit – character, capacity, capital, cashflow and conditions – before offering credit or signing new customers.

  1. Character: Research the people behind the organisation you are dealing with. It’s important to assess a person’s willingness to pay, based on their overall attitude, their company values and the financial track record of the business and its leaders. Check for any signs of a dark financial past.  Factors such as past defaults or court actions can give important insight into the financial and ethical standards behind the people running the business.
  2. Capacity: Assessing the prospective organisation’s capacity to generate sufficient cash flow to cover any outstanding debts should be the highest priority of any credit manager. This is critical before investing in a company or extending a large amount of credit.
  3. Capital: Understand your customer’s capital base, including their cash and other assets, as well as shareholder commitments. This is important to ensure credit has not been extended to an organisation that can’t afford to repay their debt.
  4. Cashflow: Cashflow is the “lifeblood” of any business. Poor credit control will greatly affect cashflow and the ability to pay debts on time, so it pays to develop an understanding of the financial situation of the business to which you are extending credit.  This will give you an indication of how swiftly they may pay you for your products or services and the likely impact on your company finances.
  5. Conditions: The current economic conditions in each marketplace may affect the ability of a business to repay debton time, which may require adjustment of your credit policies. Consider factors such as the impact of international economic conditions on the domestic market, such as offshore financial volatility and fluctuating exchange rates, as well any changes in the political landscape. Is the prospective customer susceptible to economic downturns?

“Organisations should undertake a thorough background check on company owners and directors and not just the business entity itself. Assessing the credit risk of a potential creditor should be a number one priority for any business looking at taking on new customers and suppliers,” said Samaha.