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Warning signs of Financially Distressed Customers

For CFOs (Chief Financial Officers), there’s not much worse than finding out too late that a customer is financially troubled and is unable to pay their bills.

That’s why it’s important for your team to constantly have a pulse on customer risk and exposure, says Ed Bell Senior Management of Credit Administration at W.W. Grainger.

But what are the early warning signs so your team will know when to raise a flag, so your company can avoid unpaid bills and troublesome relationships?

The following are 10 telltale warning signs that a customer may be in trouble financially:

1. A change in payment patterns

First and foremost, if a customer starts exhibiting negative behaviors, especially if they didn’t previously – such as missing payment deadlines or continually falling behind on invoices – they could be in a financial bind. Bell says you should also be a bit wary if a customer asks to:

  • Increase payment terms (e.g., from the standard 30 days to 45 or 60 days);

  • Partial pay invoices with no prior discussion or agreement;

  • Reschedule payment agreements; or

  • Plan repayments over multiple payments instead of paying invoices in full.

2. A shift in buying habits

Another sign of a financially troubled customer is if their purchases change drastically. For example, if a customer was consistently buying the same product/service from you and that changes suddenly (e.g., quantities, different items) , your team should keep an eye on the situation.

And that doesn’t just apply to if your customer is buying less (i.e., an indication they don’t have the funds to buy their usual quantity). If a customer suddenly starts buying more, they may be trying to boost inventories before a bankruptcy filing, knowing they may not be liable for the products later on, Bell explains. This customer may also need the extra inventory to get them through the bankruptcy process, especially since there’s currently a tight credit market limiting the funds available for restructuring.

3. Dwindling cash flow

If your customers are publicly-traded companies, your CFO has access to customers’ financial statements. They should be monitored to see if and how profitability and liquidity changes over time. It should also be known how much customers rely on equity, short-term debt, or long-term debt, Bell advises, to see if they can maintain their operations through the generation of cash flow.

4. Higher (and unreasonable) demands

Is a certain customer making more noise than usual – returning items, unreasonably taking discounts, claiming damages to product or making unreasonable demands on delivery? It’s typical for financially distressed customers to start pushing the limits, making requests and demanding discounts that aren’t the norm, Bell says.

5. Large accruals

A financially distressed customer often has large accruals on their balance sheets. If you see them, it’s worth looking into and finding justification. (Note: Your team should be able to find this information in annual reports or SEC filings.)

6. Withholding of financial information

Imagine that for a long time, a customer provided financial info for your team. Then seemingly out of the blue, they say they aren’t able to do so anymore – maybe even giving a reason, such as “it’s against our policy now.” That, Bell says, hints that they might have something to hide. This financially distressed customer may want to keep any problems under wraps – and your company in the dark.

7. High Days Sales Outstanding (DSO)

If a customer has fallen behind collecting their own receivables, it may have trouble paying you. Bell says to ask, “What have sales and receivables done over time?” If a customer’s sales have stayed consistent but receivables have gone up, it’s an indication that they have a problem collecting receivables, which negatively impacts their cash flow. The lack of information about companies’ supply-chain programs affects key financial metrics used to assess the health of a business and can cause issues for shareholders and other users of financial statements.

8. Management changes

This is less of a red flag, but is still something to be aware of. Changes in management could mean that there’s a disagreement between executives and the company’s board of directors or owner, Bell says. Your CFO will want to keep an eye on customers going through major overhauls.

9. Persistent rumors

Your CFO should also stay tuned in and listen for any negative news or learned information about your customers. This is especially important when it comes to privately held companies, since they’re harder to obtain information from in general. Encourage your team to maintain open communication between sales, operations and credit personnel to stay up to date and keep an ear to the ground.

10. Tax liens

A tax lien against a company is a pretty sure indicator that they are going under, Bell says. You will want to make sure your finance team understands and stays alert for any news on tax liens.

If you are a business owner or CEO within the San Francisco Bay Area or Silicon Valley, in need of an experienced part-time CFO to help your company improve profit margins, accounting and billing process management, as well as cash flow, our highly skilled outsourced CFO services provide direct access to high-quality expertise in a cost-effective manner.

CFO Growth Advisors (CGA) specializes in unique and highly effective growth strategies that are tailored to help companies grow more quickly and efficiently while improving sales & profit growth. Contact us to learn more.

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