Risky (Small) Business

Many credit managers tell me that monitoring their big accounts is relatively easy: they get information on their public customers from quarterly financials; and they routinely visit, work with their sales people, and/or obtain financials on their large, privately-held customers. The big gap for most credit managers is in the millions in credit risk offered in lesser, individual credit lines to small companies.

Why the gap?
In the past, there hasn't been much concern over losing 2 or 3 small accounts that owe you $20,000 total. However, with default rates increasing dramatically, these smaller credit losses can be significant as the numbers of accounts defaulting is increasing.

One challenge is the lack of information available on these small businesses. Bureaus don't usually overwhelm us with their massive information feeds on small business pay habits and financial condition. Many small businesses do most of their trade with other small companies who don't report to bureaus, adding to the difficulty of monitoring risk.

How can we better manage these small business risks?
While so many companies rely on credit reports, we know that slow pay indicators, whether customers slow down payments to you or to other creditors, are reactions to cash flow shortages and can be too slow in coming for us to recognize problems until it's too late to react to the risk.

Our challenge, then, as creditors, is to recognize trouble before it starts by understanding small businesses and how they end up defaulting on payments:

1) Customer Concentration. Do you know if your customer has a client that accounts for more than 10% of their sales? If so, you'd better know who they are and make sure you're on top of THEIR credit worthiness as well as the contractual relationship between them. If it goes sour, so goes their ability to pay you.

2) Cashflow management. Are they collecting their receivables timely? What is their cash conversion cycle? If you don't obtain full financials, at least ask the questions to understand these trends. If they can't convert sales to cash timely, they will have trouble meeting obligations (including paying you).

3) Bank relationship. Most small companies are extremely dependent on bank credit lines. Do you have information on these? Are you monitoring them? Many banks are terming out credit lines now on higher risk customers or just asking these accounts to leave the bank. What do you know about this for your small customers? You should not be the last to know the relationship between your customers and their banks.

4) Public filings. Are you monitoring public filings (liens, judgments, bankruptcies) on these small companies AND their owners? You should be getting daily updates on these to keep up on important risk changes to react accordingly.

5) Market trends. Do you know what type of business your customers are in and how they're adjusting to market changes? If they're not responding to changing customer demographics, evolving demand, and/or new technology, they could be headed for default.

In our world of monitoring thousands of risks, we're tracking all of this data and 'scoring' the risk appropriately depending on what we find. Determining risk is more than just pulling a credit report, reading it, filing it, and deciding whether you'll join the large creditors or set a conservative line.

Extending credit to small businesses is a dynamic, ever-changing, complex process that you need to understand. Once you know the real risks of small business, you can gather the right information and make the appropriate decisions. Without it, you can count on many surprise losses coming your way in the next few months.