Who is more exposed to this risk? Companies with concentrated exposure to a single or a few large clients are considered as a ‘fragile population’. The risk is exacerbated if long credit terms are offered or the company is a critical supplier to the client in question, thus making it quite difficult to catch the early warning signals.
The big questions facing suppliers are: how easy is it to spot the warning signals, and what preventive measures can you take? The following are just some of the potential red flags. The more you spot, the higher your chance of being impacted!
The first is a history of liquidating other businesses. If the owners or directors have done this in the past, it means that they are familiar with this option. If you have a concentrated exposure to a large client, and especially if you are a critical supplier, it is worth investing in an external source of information (a credit bureau) to check the directors’ history, get up-to-date payment patterns, and an idea of your client’s buyers.
A second red flag is the non-strategic nature of operations for subsidiaries of large groups. If your client is part of a larger Group, it is worth considering some key questions. Is the subsidiary I am dealing with in a good financial position? If not, will it be supported by the Group? Some factors that might influence the Group’s decision to support a failing subsidiary are:
- Does it carry the same name (reputational risk if the Group lets it fail)?
- Is it integrated within the Group? In other words does it produce products or services that are necessary to the rest of the Group?
- Is it sizeable enough and considered as a core activity?
- Does it have independent bank lines? Is the Group a guarantor of the company’s loans?
- Is there in the annual report a special resolution authorizing the Group to financially support its subsidiaries?
A third indicator to watch is your client’s management and strategy. A frequent risk associated with large corporations is complacency, notably the illusion that success will be on their side just because they are too big to fail! The good news is that the wrong strategic choices (failure of large projects, loss of competitiveness, high operating costs etc.) tend to take time to impact companies financially. If your client is a listed entity, it is worth considering the ‘noise’ of the stock market and weighing it objectively even if everything is running smoothly day-to-day.