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The Warning Signs of Bankruptcy: What Creditors Should be Watching For

Originally published: February 2014


Data from The Administrative Office of the U.S. Courts indicates that the overall number of bankruptcy filings have declined over the past few years, which is great news for U.S. creditors. Nevertheless, learning that even one customer may be facing bankruptcy is enough to send a creditor into tailspin – especially if that customer makes up a large percentage of the company’s business. What can you do to prepare your company for a client's impending bankruptcy filing? What are the warning signs you should be looking for; and what can you do to diminish your company’s risk?

This article outlines some of the most common signals of a failing company and summarizes a few best practices for minimizing the repercussions for creditors.

Payment Changes

You've always had a great relationship with your customer - they have consistently been responsive, paid on time, and their credit line has remained level for a number of years. However, things have recently started to change.
  • There's been a change in payment patterns: i.e. they used to pay on time every 30-35 days but are now paying close to 40-45 days
  • You've started receiving post-dated checks and/or check holds
  • Checks have bounced
  • They've requested an increase in their credit line

Third-Party Actions

In addition to the personality changes you've experienced with this client, their reputation in the industry has also been altered.
  • Collection activity is showing on credit reports
  • Credit rating has been downgraded
    • Moody’s
    • Standard & Poor’s
    • Fitch
  • Loss of credit insurance
  • Late SEC filings/Delays in release of financial information
  • Falling stock/bond prices
  • Delisting from Stock Exchange

Industry Trends

As technology continues to change at lightening speed so do industry trends. In America, several of the top industries of yesteryear will soon be nothing more than memories of the past. How many of your customers operate in declining industries? Do they require raw materials that have become cost-prohibitive?  Have changing consumer tastes affected the demand for your customer’s products or services?  These are some of the questions you should be asking as you look to determine whether or not your customer is on track for a future bankruptcy.
  • Multi-year industry decline
    • i.e. miscellaneous manufacturing; textiles; newspaper, book and directory publishing
  • Increased overhead/operating costs
    • i.e. higher raw materials costs
  • Changes in consumer tastes
  • Increased competition from low cost imports

Company Changes

Many times the insight you seek is no further than a phone call away. Is the person you’ve always dealt with no longer there? Or is your long-term contact giving you inclination that business hasn’t been very good lately? Ask questions. Talking to your payables contacts may shed all the light you need on whether or not things are starting to go south for your customer.
  • Management changes
    • i.e. change of CFO, CEO or Board of Directors
  • Headquarters have moved
  • Company had been recently sold or merged with another
  • Major product lines have been discontinued or sold off
  • Corporate layoffs are taking place
  • Employee perks are being reduced or eliminated
    • i.e. pension, stock, 401 (k) match, healthcare

Conclusion

The longer you’ve had a relationship with your client, the easier it will be for you to recognize the signals that indicate things aren’t quite right; and oftentimes, your gut will tell you when you should be investigating further. However, there are a number of sources to help you get the factual information you need, such as your trade associations and credit groups, other vendors who deal with the customer, salespeople in the industry, and insolvency professionals such as: attorneys, financial advisors/investment bankers, crisis managers and turnaround consultants. There are also public resources available, such as local and national newspapers and websites, pending litigation searches, SEC filing information, lien searches, credit checks, stock/bond price quotes and distressed debtor reports.

Above all, the best defense is a good offense. In order to protect your business, you need to be proactive and take all the necessary steps to minimize potential losses from a failing customer. The following are a few, simple best practices to help mitigate risk:
  • Use credit applications.
  • Verify customer’s credit history regularly.
  • Require a guarantor or cosigner.
  • Cash checks promptly or require cashier’s checks/money orders.
If the future of your company is too dependent on the success of your top clients, you could be in jeopardy. Diversifying your customer base will help ensure your company won’t be next in line to file for bankruptcy because one of your top customers recently did.