Is your new client a financial hazard? Why due diligence could save your business
Do you provide a product or service to others businesses without receiving full payment up front? If so…
How well do you really know your customers?
At Zenith, our business is arranging finance for other businesses – anywhere from a few thousand to tens of millions of dollars. So we make a big deal about getting to know their financial position, history and ability to repay debts as well as we can. Before they become clients.
In the finance industry, due diligence is a given. But really, any business that hands over goods or services before getting paid in full should be doing the same.
The debtor snowball effect
It always surprises me how many small to medium sized businesses are prepared to do work for, or supply products to, new clients without doing any credit and reference checks up front.
They perform the job, or deliver the goods, send out an invoice and just assume it will be paid within 7, 14, 30 or 60 days as per their trading terms. Sound familiar?
But what happens if your client tells you they can’t pay right now? Can you afford to go into debt to pay your own suppliers, staff and bills? Or will you have to beg for extra time too?
Whether you are providing a few thousand dollars worth of web design, legal services or retail goods – or five million dollars worth of construction equipment, you need to be doing due diligence on the financial credibility of perspective clients before you sign any agreement.
Credit insurance claims are rising
There’s no doubt that the economy is improving, but many businesses are still struggling with cash flow problems.
Credit Insurance Brokers figures show that in the Jan – Mar 2010 quarter, credit insurance claims were 67% higher than the average over the previous five years. And more debtors were defaulting due to insolvency.
The main reasons why many small to medium businesses are unable to repay their debts include:
- lags from the global financial crisis
- rising interest rates
- decreased government stimulus spending
- tighter bank lending to SME’s
- the ATO’s tougher position on outstanding taxes.
Give the gift horse a proper check up
The US housing crisis showed that when people at the top of the house of cards can’t repay their loans, it has an effect on everyone down the line of creditors.
Even a healthy business that provides products and services to others on credit can run into trouble if they don’t undertake due diligence on new customers.
In times when you’re under a bit of pressure, and just happy to get some business through the door, it’s even more tempting to say yes to a gift horse without taking a look around inside their mouth to make sure those shiny gold fillings are solid, and not thinly plated.
Think more like a bank and less like a charity
If you go to a bank to borrow $50,000, do they immediately smile, lean across the table, shake one hand and slip a big fat cheque into the other? We wish!
Instead, they ask for copies of your financial statements, do credit and reference checks and want to know about your assets. They’ll grill you over how long you’ve been in the industry. They’ll also want to know when you started your business and ask for your personal guarantees on loans.
As a supplier, you are like a bank to your clients (a warm-hearted caring bank, of course), but a bank none the less. So you need to think and act like a business that’s going to be owed money by another business you don’t know much, if anything, about. This means:
- doing credit checks
- checking credit reports with reference checks (if possible).
What to look for when doing due diligence
- Examine trends eg are there a high level of enquiries into debts and any defaults?
- Extended payments eg have the usual 30 day payments stretched out to 45 days?
- Current disputes – do they look like they’re being used as an excuse to delay payments?
- General business management – if they struggle to manage day to day business, how will they manage their finances?
The more baskets the better
Even with thorough due diligence there are going to be times when you have to chase, or even write off, a debt. The best way to protect your business is to work with a range of customers. The more baskets you have, the less damage one bad egg can do.
Yes, some people may object to you questioning their financial position. Some may even refuse your due diligence request. Perhaps that means they have something to hide.
Doing comprehensive checks up front and spreading your risk amongst a wide range of customers can save you a fortune in time, money and stress down the line.