The last few years have brought global upheaval, and as businesses continue to deal with the after-effects of the pandemic the challenge now facing CEOs and CFOs is how to  spot high-risk customers and suppliers, in order to protect their company against insolvencies and  grow their business.

The  risks associated with customer insolvency are clear: without adequate protection, not only do you face potentially devastating financial loss if you sell on credit terms, but there is also the potential for protracted (and costly) legal proceedings.
Meanwhile, the risks related to supplier insolvency may seem less direct, but they can be just as negative – ranging from lost down payments and deposits, to interrupted production and service delivery, which can also lead to business insolvency.
It is vital to identify insolvency risks in your supply chain, but what exactly do high-risk customer and supplier companies look like?

Identifying high-risk customers

Head of Group Credit Underwriting at Allianz Trade, Marine Bochot, explains that identifying high risk customers involves a number of factors. One that has a big hand in the domino effect, is what  sector a customer operates in: “Businesses in the hospitality, non-food retail, air industry and automotive sectors now represent a higher risk of insolvency,” Marine explains.

“That’s because borders have been closed, traffic has been minimal, mobility has been stopped, people haven’t been able to meet or move, and they either haven’t been able to consume, or they consume differently – for example online.   

“In fact, many businesses in sectors that rely on physical exchange and social interactions for goods and services were hit first by the Covid crisis. So, they have experienced more intensely the need to quickly adapt their operational models and cost structure. Companies that lack this agility are more exposed to business insolvency and a potential domino effect in the supply chain.”
The passenger airline industry is a prime example of this. Those airlines with the agility and flexibility to convert or reinforce part of their traffic from passenger to cargo performed much better during the pandemic.

Sector vulnerability means that customers related to that sector are at greater risk of the insolvency domino effect. Air transport (equipment and services) and non-food retail for example are unlikely to fully recover until 2023 at the earliest, making companies in these sectors  a greater risk as customers.

Other factors increasing company vulnerability include heavy reliance on cross-border trade and an under-investment in digital transformation.

Weakened balance sheets and poor cash flow is a red flag for CFOs and their credit managers. This risk category includes supply chain customers already struggling with high debt or those saddled with high-interest costs and high fixed cost structure. It also covers businesses with thin operating margins and those experiencing difficulty meeting their financial obligations.

Marine says: “The companies most at risk within this group are those that were not quick enough to secure state guaranteed loans. Vulnerable companies without state support have generally been confronted with bankers who are shy to offer loans on medium credit profile risks. This puts them in an even tougher position.”

Spotting signs of financial distress and insolvency risk means asking the right questions. Generally speaking, the more questions answered with ‘yes’, the greater a company’s risk level.
 

  • Is your customer taking longer to settle invoices?
  • Have they asked to renegotiate contracts?
  • Is there a trend toward late deliveries… or even disputes?
  • Are funders refusing to support your customer during renewal facilities?
  • Have they attempted to switch to alternative funding sources?
  • Are their stocks performing badly? Are they being shorted?
  • Have the credit default swaps (CDS) prices increased?
  • Has your customer recently lost a major client/supplier? 
  • Are they attracting negative press coverage?
  • Have any C-suite members resigned unexpectedly?
  • Is your customer unable to pay employee salaries/social charges?
  • Have they appointed restructuring advisors?

Marine says visibility and awareness of risk is paramount: “The situation is complex, so you need to have 360-degree visibility of what’s happening around you and your partners.”

Achieving such a granular level of insight is not easy, especially for embattled SMEs who may find their resources stretched to the limit during tough economic times. 

Marine concludes: “If you have trade credit insurance , remain in close contact with your insurer. More than information providers, they have skin in the game, so it is in their interests to give you the right levels of understanding to effectively manage the risk within your supply chains and recover potential bad debts.

"If you don’t have trade credit insurance, I highly recommend you get coverage right away. If you are determined not to get insurance, you should at least buy a risk grade as in most cases it incorporates the probability of default of your customer.”

An effective trade credit insurer will do everything within their power to identify high-risk trading partners and break the chain of potential insolvencies before it can start. Our risk assessments are based on data from our proprietary intelligence network which analyses daily changes in corporate solvency representing 92% of global GDP.

 

When companies are faced with a chain reaction of insolvencies throughout global supply chains, data of this granularity will continue to provide the confidence to trade, and be paid, no matter what.

The third article in our Insolvency Domino Effect series focuses on the proactive steps businesses should take to protect their businesses from supply chain risk.  

The financial failure of others can hurt your business in surprising ways. Trade credit insurance can protect your enterprise against that risk.
Do you have a protocol in place if one of your customers is struggling to pay? Check out this checklist to maximise the chances of getting your money back.

Many companies will have to restart afresh. They will have to behave almost like start-ups, with the financial risks typical of a new comer.
There are several options and tools to mitigate credit risks. You should weigh the costs and benefits of these options and investigate carefully to determine the best fit for your company.