Managing Your Cash Flow

Top 5 bad debtor red flags

4 min read

02 April 2015

Despite the recent economic upswing, financial risk remains a problem for businesses across all sectors. Marine Bochot, UK head of risk at Euler Hermes, provides her top five red flags to protect your business from bad debtors.

When businesses find themselves in financial difficulties, it is often the case that proactive action could have been taken in the previous months to avoid the problems. Insolvencies rarely occur without some sort of warning, particularly when it comes to bad debtors.

Some signals are quite overt, while many are subtle and go unnoticed. It is these understated signals, commonly presenting themselves in advance of bankruptcy, that are important to recognise. Being aware of them can enable companies to take the appropriate steps to steer clear of bad debt and the associated financial issues that can arise.

(1) Large, first-time orders

In the scramble for revenue, businesses can sometimes jump to welcome a large order (at full price) from a new customer, often out of the blue, without doing the necessary checks.

This red flag is usually typical of a fraud – in this case the debtor should be keen to gain trust from the supplier by offering and giving relevant financial statements that are made available well ahead of deadlines and which often show above average performance for the sector. Non-payment, or even a delayed payment on a significant order can leave a company in severe difficulties, and the prudent question is to ask why the debtor did not want to negotiate on price in the first place. Appropriate credit checks should always be taken to ensure a debtor’s legitimacy and financial viability. 

(2) Slow account payments

A substantial rise in your day sales outstanding (DSO) with a particularly customer – specifically when goods are being delivered when unpaid debts are already over 90 days old – is a warning sign that should be addressed immediately. 

If the company in question is only making payments when reordering product, looking to change its payment terms or just generally failing to comply with the credit agreement previously adhered to, the firm is likely to be suffering from a volatile cash flow, with payment dependent on various other factors. 

(3) New financial arrangements

If a debtor company is in the process of getting new financing or changing banks it can mean one of two things. The move could be to fuel a major expansion which would be a good thing for future business. However, it also may be to cover large losses and the customer should be treated with caution. 

(4) Continual credit enquiries

A constant stream of checks from credit providers can either represent a positive growth indicator or a need for prudence. Your customer may be going through a key growth phase which may include expansion into new markets. Conversely, it may signify that the company is having trouble paying its current creditors or desperate for credit to cover financial losses – other suppliers may also be nervous about potential bad debt.

(5) Frequent excuses

Continued excuses from a debtor for not delivering payments or other business-critical activities is generally a tell-tale sign that trouble is on the way. The reasons given often include problems with computers and telephone systems, an audit is currently in progress, the cheque signatories are away or unavailable, the company is restructuring or changes to bank and finance arrangements are taking place.