Analysing the credit decision
It has emerged that the government has spent over €100 million on professional advice related to the banking sector since 2011 – a goodly portion of that sum on analysis of the state of their loan books.
It is beyond the scope of this article to offer a view on the value received but it is a fact that the vast amount of credit controllers and credit managers in the land should be taking a far more systematic approach to analysis of their debtors’ ledger. Most fail to undertake anything other than rudimentary risk assessment.
The reality is that any business granting trade credit to another is effectively becoming a quasi-bank to that counterparty, with a dual exposure relating to interest free credit and default risk on the value of goods and services supplied.
The first step in the process is to undertake a credit checking exercise
on any prospective customer from a reputable agency; the next is to do the same for all other companies in your ledger, beginning with the largest exposures. The score will normally be accompanied by a recommended credit limit; you should also get information on any registered judgments against the company or its directors.
StubbsGazette’s proprietary credit ratings service is the prime arbiter of an enterprise’s creditworthiness. The credit ratings provide a numerical score from 0-100 and are categorised as follows:
80 - 100 Low Credit Risk
60 - 79 Reasonable Credit Risk
44 - 59 Acceptable Credit Risk
0 - 43 Assurance or Guarantees Advised
StubbsGazette’s credit ratings are calculated according to a range of factors including financial data, judgments, unsecured creditors, demand letters and proprietary StubbsGazette collection data.
The methodology used in arriving at a single figure credit rating is as follows:
Each company starts with a score of 100.
If latest company accounts date of filing is more than four years old, 100 points are deducted leading to a zero score. If the last filing date is more than 680 days we deduct different amount from the score depending on the age of the accounts.
Points are deducted according to various financial parameters and relationships:
• Value of total assets and current ratios.
• Difference between current ratios and previous current ratios.
• Value of total assets and liquidity.
• Movements in profit and loss reserves
• Value of total assets and shareholders’ funds and relationship with total assets
• Long term liabilities to total current liabilities ratio and relationship with total assets
• Long term liabilities to total assets ratio and relationship with total assets
• Existence of valid judgments, unsecured creditors, debtors’ letters or debt recovery data
The credit score you receive from an agency should be the foundation of your own credit scoring system. By supplementing the score with your own analysis you can in many instances extend the recommended credit limit.
Credit insurance can reduce your risk exposure but the limit you are offered by your insurer also indicates levels of risk.
Payment patterns also need to be analysed systematically. Past payment behavior is the best indicator of future behavior. In this respect the number of days taken to pay creditors is a valuable credit metric. This is calculated as follows:
Creditor Days = Trade Creditors / Sales * 365
The industry and even the industry sector are also material influences on the credit decision. Is the debtor or prospective debtor in a thriving industry such as food and drinks or in an industry sector at a much weaker stage in the cycle as the construction sector has found itself for the past few years?
Indeed, the StubbsGazette Food and Drinks Industry Report 2014
gives a good example of this. Analysis of the creditor days taken by each individual sector in the 3,000 companies analysed for the report shows the wide variance with an average of 44 days but a wide variance between Dairy (30 days) and the worst performer, Beverages (66 days).
Last, the amount of credit extended depends also on the cost of the goods or services you are supplying: the lower that cost relative to the selling price, the lower your financial exposure.