Oct 18, 2012 10:21
In today’s uncertain economic times, businesses have to be more cautious about who they do business with. Businesses have countless suppliers and moving parts, how is a business owner supposed to identify a singular high-risk area? To help business owners, Sageworks has identified multiple scenarios where a business should conduct a financial due diligence analysis.
The first area of concern should be suppliers. Almost every company is dependent on suppliers and if they are not financially sound, it affects the company’s ability to generate revenue and hence, it makes it more critical to evaluate suppliers’ financial health. DePaul University Professor of Finance Rebel Cole adds that in addition to affecting your ability to generate revenue, a supplier going out of business can also affect your cash needs. “They may be offering you trade credit and therefore you could be losing one of your sources of financing,” he says.
Distributors and vendors pose a tremendous business risk that warrants vendor credit checks. These firms are outlets for a company’s products; it is a way to get these products to market. When a vendor goes out of business, it diminishes a firm’s ability to go to market and generate revenue.
Additionally, if a vendor defaults you may have to identify another vendor so that your products can continue to be sold and distributed. Again, this risk can lead to lost revenue and sales channels.
Running a business credit score on customers is important. Any company that does business on credit should run a probability of default calculation, which indicates the risk level of the customer. If you extend a customer a line of credit and they default, you lose sales, which are going to affect the firm’s bottom line. “If they go under, they directly impact your ability to supply your goods and services and make money,” Cole says.
Financial companies considering extending a loan or any credit to a business customer can use a business credit report to see how creditworthy that company is currently and to predict its likelihood of default. When a credit analyst is trying to assess the risk exposure tied to a new credit line or credit line increases, pulling a report on a company’s default risk and combining it with a loan file can provide a more complete understanding of the risk exposure.
Companies Conducting Self-Evaluation
One area that many business owners overlook is their own firm. An assessment of your current situation and the probability of default can help create a more complete picture. It helps business owners better understand the true financial stability of their company. This is extremely important when a company is considering applying for a loan. Knowing your own business credit rating prepares you for potential objections on the part of a lender and can build credibility as you negotiate on rates and fees.