Thanks to a massive injection of state-funded liquidity into global markets, many companies haven’t had to deal as much as usual with late payments and insolvencies recently. But as our article Insolvency risk: understanding the Covid-19 domino effect points out, this situation won’t last.
With governments expected to begin phasing out state support this year, the challenge now facing CEOs and CFOs is how to spot high-risk customers and suppliers to protect their company against insolvencies.
The Differences Between Customer and Supplier Insolvency Risk
The risks associated with customer insolvency are clear-cut: 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.
Identifying insolvency risks in a supply chain is critical, but what exactly do high-risk, Covid-sensitive customer and supplier companies look like and are they easy to spot?
Tips to Identify Covid-Sensitive Customers
According to Marine Bochot, Head of Group Credit Underwriting at Allianz Trade, identifying Covid-sensitive customers can be complex as it often involves piecing together a jigsaw of factors, which combine to heighten the risk of business insolvency.
Marine explains that one of the key factors that increases insolvency domino effect risk is the sector in which a customer operates. “For example, businesses in the hospitality, non-food retail, air industry and automotive sectors now represent a higher risk of insolvency,” she says. “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 have been 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. The airlines with the agility and flexibility to convert or reinforce part of their traffic from passenger to cargo have performed much better during the pandemic.
Business Insolvency Risk Factors
Our recent report Vaccine Economics reinforces this focus on sector vulnerability. It points out that a business insolvency domino effect could start impacting companies during H2 2021 and that the majority of sectors would fail to return to pre-crisis levels of turnover and profitability until early 2022. Meanwhile, air transport (equipment and services) and non-food retail are clear outliers, unlikely to recover until 2023 at the earliest, making companies in these sectors more vulnerable to the domino effect and a greater risk as customers. Other factors increasing company vulnerability include heavy reliance on cross-border trade and an under-investment in digital transformation.
Businesses with significantly weakened balance sheets and poor cash flows are another 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.”