The danger of judging credit risk on face value


We all know the story with icebergs: only an eighth appears above the water, making it hard to judge the true size and nature. From the outside, you can’t see the cracks on the inside that could cause the whole thing to fall apart.


It’s the same with businesses. What may look like a well-run business on the outside could have serious internal problems that may jeopardise the viability of a business relationship. Just because a business is big and reputable, or has glossy brochures and a flashy website, doesn’t mean it is an ideal customer. You wouldn’t believe the size of the companies on Australia’s worst payers list. Many of them get away with it because they bully other businesses, or they are only slow to pay certain creditors.

To find out if there are cracks inside, do your due diligence. This may include substantiating their company and legal status, looking at credit history, and gathering testimonials from their current creditors.

Just like icebergs have glaciologists, businesses have debtor registers and credit reporting agencies such as CreditorWatch to collect data and analyse the results. This information will help you decide whether to take someone on as a debtor.

Businesses often get stung when they find out they have been chasing a debt from a company that doesn’t exist. A credit check will bring up the trading name and the company name of a business. This distinction is important when you are after money owed; you need to address your invoices to the company and all follow-up correspondence needs to be addressed to the company, not to the trading name.

Make bad debts history

Credit status will tell you how risky it is to extend credit to the business. Even if it has a good credit status, it’s advisable to look at their credit history as well, to note any payment delays or defaults in the past. There may be good reasons for the occasional delay: ask if you’re unsure of what the data indicates, and note any patterns.

Maybe this debtor tends to forget about smaller invoices, smaller enterprises or businesses in certain industries. Consider asking for a credit testimonial from a business similar to yours. Ask yourself whether you’re willing to accept that behaviour. Perhaps you can formulate credit terms that will counter it.

Once you’ve ascertained that the iceberg is solid, don’t assume it will be solid forever. A business relationship is a living thing – don’t just ‘set and forget’. Check for warning signs regularly, even if you just keep an eye on the news once a week for shifts in the business environment. It is good practice to do a debtor check every month or so, just to ensure the health of your cashflow. You can do this in your own record keeping by invoicing promptly and setting reminders to chase debtors if you haven’t been paid by a certain time.

If the debtor knows you’re monitoring them, they are more likely to pay on time. This is especially true of larger companies that may otherwise get away with bullying smaller companies by withholding payment. Big companies have more to lose when their reputation is at stake.

After all your due diligence, if you still want to do business with a risky debtor then one defence against becoming a bad debt victim is to set credit terms that favour you. Try to match your risk appetite with the payment method and be clear about why you are considering an alternative to the standard 30-day invoice.

The Holy Grail is to get your client or customer to pay upfront, but this is not always possible due to market forces. Other favourable credit terms you could consider include the debtor paying you a portion upfront and the rest at an agreed time, or the debtor paying you in regular instalments. Limiting the amount of credit you lend is also advisable.

Colin Porter is managing director of CreditorWatch

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