Who Needs to Know?

When my teenagers approach me with a bit of fear in their voices, I know they're about to ask me for money. Generally, they're not asking for school lunch money because that conversation goes more like "I need money for lunch". It's easy for them to be direct and confident when they know the answer is a foregone conclusion. It's not so easy for them to ask us if they need money to go to the movies or shopping for clothes they don't need. Then, we parents start firing questions like: "why do you need that?" or "didn't you just see a movie with your friends last weekend?"

I've had a number of conversations this week with financial people who are fearful about asking their customers for financial information. Just as with my teenagers, 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 creditors.

Credit managers tell me customers don't want to provide financials. I say there are only 2 reasons for reluctance from the customers: 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 that you'll see things they don't want to see, you should at least get basic information to help you make a decision. Many companies won't share their P&L's (for fear suppliers will think they make too much money and will raise prices) 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 better informed decisions. The more information you have about the customer, the better the credit decision.

Who needs to know? YOU DO!