Storm Warning: Private Company Red Flags
17 Warning Signs a SMB Customer May Be a Default Risk
The United States has witnessed a significant surge in corporate bankruptcies, reaching a 14-year high in 2024. Business bankruptcy filings increased by 33.5% during the 12-month period ending September 30, 2024. This trend has been driven by a combination of factors, including rising interest rates, persistent inflation, higher labor costs, and shifts in consumer spending patterns following the pandemic.
As economic pressures continue to mount, experts project a further increase in bankruptcies—Allianze Trade forecasts a 11% rise globally in 2025. Even more concerning, the U.S. Department of Justice's U.S. Trustee Program anticipates bankruptcy filings to double over the next three years, signaling a potentially prolonged period of financial distress for businesses across various sectors.
The Customer Delinquency Challenge
Successful accounts receivable (AR) management involves minimizing past due balances to ensure steady cash in-flows and limit bad debt losses. In light of the current economic environment, this will likely get more difficult. Customer past due balances cause cash flow shortages, increase the need for borrowing, and create a significant work requirement in order to accelerate collections. When you do eventually get paid, you recover the cost you expended in fulfilling the customer order less the cost of collections and any interest on loans. The following table outlines the things you can do to limit delinquencies.
Moderate levels of customer delinquency are not likely impactful enough to cause a firm to fail, though the diminished cash flow can impact organizational objectives. High levels of delinquency, however, can significantly damage cash flow, severely limiting your organizations options. In contrast, customer bankruptcies or other defaults typically cause the loss of most, if not all, the AR owed.
Customer defaults can be devastating, especially when they cause a substantial bad debt loss. This is money you expended on the customer’s behalf, which now cannot be recovered except through new sales that are many multiples more than the loss, depending on your gross margin. A large volume of bad debts can render your firm insolvent. At lower levels, bad debt losses may still require you to:
Borrow funds at high interest rates with restrictive loan covenants or give up some or all control of firm in order to attract new capital.
Cut costs dramatically, damaging your firm’s ability to serve customers — this is especially true when you must lay off key workers, who may be difficult to re-hire if and when your business recovers.
If you are selling public companies, a single bankruptcy can have a huge impact on your firm. Fortunately, you usually have time to prepare because public firms are required to share their financial information, making it relatively easy to identify customers that are floundering. This was discussednin a previous article: Big Company Red Flags You Can't Afford to Miss.
Private firms, in contrast, are much less likely to share financial information—you should still require them to provide financial statements if the credit you will be extending to them is substantial. Without financial insights, however, it is much harder to identify financially distressed customers. Not being able to look at their books, means you have to look for external factors, particularly when dealing with small and medium-sized (SMB) businesses.
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Do you need help improving cash flow? The experts at Your Virtual Credit Managerhave default risk probabilities and other financial benchmarks for analyzing your AR portfolio and revealing actionable credit & collection insights.
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Please share this newsletter with your small business customers . . . it just might help them collect faster and pay you sooner.
17 Warning Signs a Customer May Be a Default Risk
With private and smaller firms, cash flow is the lifeblood of the business. Access to other capital is often limited and expensive. With that in mind, the following red flags, many of which point to cash flow issues, provide indicators that a customer is struggling and possibly headed toward defaulting on the debts they owe:
Each payment later than the previous — indicates constricted cash flow
Changes in payment patterns — for example, instead of averaging 7 days beyond terms, payments may be 20 or 30 or more days past due some months, while at other times the customer will pay close to the due date — this is an indication they are having cash flow problems that are likely to get worse
Deterioration in payments to other suppliers — visible in a new credit bureau report or from re-checking the customer’s vendor references
Changes in order size and frequency — a customer may be looking for credit from multiple sources, which can be exacerbated if they are constantly bumping up against your credit limit
Requests for an increased credit limit — re-check their other vendor credit references and a credit bureau report to see if their credit utilization is high: a lack of credit availability could be causing cash flow problems
Requests for extended payment terms — see above
An increase in credit reference requests — they customer may need to obtain credit from new vendors because they are behind in paying their current vendors
A noticeable increase in requests for invoice copies or other documentation — they maybe stalling for more time
An increasing volume of partial payments and payment deductions — this is another indicator of cash flow problems
An increase in disputed invoices & unwillingness to pay short — further indications of cash flow problems
Repeated broken promises to pay — they may be having trouble collecting from their customers, and therefore are having trouble managing cash flow or stalling for time
Bounced (NSF) checks and other payments defaults — a clear indicator of cash flow problems
Inability to contact the customer (no response to phone calls and no email replies) — have sales confirm they are still in business, and, if so, deliver your message
When they admit to having cash flow problems — re-check their other vendor credit references to compare notes and gauge the extent of the problem
Your sales team’s observations from on-site customer visits (for example, depleted stock, low level of activity) — get a new credit report and re-check references to gauge the severity of the situation
New Derogatory Information (Suits, Liens, or Judgements) — visible in a new credit bureau report or via a credit bureau change monitoring service
Deterioration in risk rating/score — from credit bureau report or monitoring service
Final Thoughts on Protecting Your Business from Customer Defaults
Selling profitably to slower paying customers on credit terms is often necessary, especially in a weakening economic environment. First you need to identify the customers at risk, then, by following the steps described near the beginning of this article to minimize delinquencies, you can reduce the risk of crippling bad debt losses. The key activities are:
Recognizing the warning signs a customer’s financial condition is weakening in order to identify your high risk customers
Adopting a tight order control process—no order accepted from high risk customers unless a payment is received in excess of the order value
Tightening your credit policies and beefing up collection efforts
The assessment of financial strength and liquidity is difficult when it comes to privately held customers. You must rely on external factors since customers are unlikely to provide financial statements. You need to, therefore, always be on the lookout for signs of financial distress and take proactive measures to avoid delinquency.