Do You Know Your Debtor's
(Copyright, 2001-2005, Business Publication Inc.)
can we tell, in today's business environment, when a company is
on the verge of bankruptcy? It is not easy. In fact it is downright
twenty years ago it was only necessary to look at a company's financial
information and their payments trends to determine if the firm was
creeping closer to a bankruptcy filing, today's financial executives
need more information. Today's executives need to be able to stay
on top of their debtors like never before.
information and more information! That is what is needed in order
to be able avoid shipping a debtor that could file a bankruptcy
petition tomorrow or several months down the road.
to know (and not necessarily in this order):
any judgements or liens been filed against the debtor?
can be as insignificant as a $5,000 judgment brought against a company
for a customer slipping and hurting himself on the debtor's premises
or as important as a $100 million judgment brought against a company
for anything from illegal advertising/ marketing practices and defective
products to toxic cleanup, etc. Judgments should be viewed in context
with the size of the company. A $2 million judgment on a company
with $5 million in sales could be catastrophic, however, a $2 million
judgment against a $10 billion firm will not affect their bottom
line as significantly.
lien however, especially a federal tax lien, could have more severe
look at the state tax lien first. Some state tax liens are issued
for failure to file franchise fees. This is often not as significant
as a lien filed against a firm for not pay its sales tax. In fact,
any sizable state tax lien (again depending on the sales volume
of your debtor) could have a significant impact on the way your
debtor would pay you.
tax liens on the other hand are generally larger than state tax
liens and often have more of an impact on a firm. The reason they
are often larger is because many federal tax liens are often a result
of companies failing to pay there 941 employee payroll taxes. These
often accumulate to large amounts and by the time the federal government
actually attaches a lien against a debtor, often six months or more
have gone by since the feds first having notified the debtor they
had to pay--and the amounts kept piling up. So by the time the lien
is actually filed by the federal government the company can often
be in dire straights. Other tax liens, for not paying corporate
taxes, 940 taxes, franchise taxes, etc., can at times, also be significant.
But the ones that you want to watch out for are the ones that are
the larger federal tax liens.
any lawsuits been filed against the debtor?
like judgments, lawsuits can be meaningful or not. A $5,000 lawsuit
against Wal-Mart Corps a result of a bar of soap falling off a shelf
and hitting a customer in the head is not nearly as significant
as a $500,000 lawsuit filed against a biotech firm that has been
in business only three years, has little capital and has sales of
only $3 million.
the lawsuit in perspective, however, is imperative. Why was it filed
? Who filed the lawsuit? Was it one of its competitors? Was there
any type of trademark, copyright or patent infringement? Did a trade
creditor file the lawsuit? This is important for obvious reasons
because you could be next on the list to not get paid. In fact,
when you see several lawsuits being filed against a debtor, look
at the most recent financial information. If it contains derogatory
information these can be invaluable signals as to whether that debtor
is on the verge of filing for Chapter 11 protection.
the debtor having any inventory control problems?
some companies a poor inventory turn can be a death knoll.
of course depends on the severity of the problem however it can
certainly have a
significant impact on the company's financial results. Analyzing
the company's inventory ratios and comparing it to industry standards
is also a useful approach to beginning to understand your debtors
get a good idea if the company is having inventory control difficulties
by reviewing its purchasing habits on a historical basis. Comparing
this with sales and then reviewing your debtor's credit exposure
with its primary lenders (and also discussing this information with
the debtor's bankers--although in many cases obtaining information
from a debtor's lender is like pulling teeth) could furnish positive
results. If a retailer, for example, is known to have outdated inventory
and their inventory purchases increase so to as include more update
inventory, you know two things: the company will discount its own
inventory to move it out the door and as a result revenues and earnings
will be affected and the company's cash flow will be affected as
a result of its drawing on its credit line to purchase newer inventory.
This is assuming internal cash flow is not sufficient to handle,
carry and pay for old and new inventory.
Its also always worth knowing if the products your debtor has in
inventory is simply outdated. Pharmaceutical companies and biotech
companies are one example where, if their products are not moved
within a specific time period, they will simply have to be discarded.
Beyond this, knowing your debtor's products and their shelf life
Tire Co. and Ford Motor Co. tire debacle is one of the most recent
catastrophic examples of inventory affecting a company's bottom
line. The recall of so many millions of Bridgestone tires certainly
resulted in inventory problems for both Firestone and Ford. The
ramifications of this had a snowball effect causing earnings shortfalls
and a number of large charges on their balance sheets.
inventory difficulties could be so severe so as to cause a company
to consider restructuring its operations or even file for Chapter
11 protection as a result of its inability to pay off its debtload
because of its immediate needs to purchase more inventory.
the debtor's sales declined.
is often a key. While a sales decline may not be as important for
companies that are selling off certain divisions or assets so they
can concentrate on their core business
operations, firms that have remained intact but still see their
sales decline (especially at greater percentages than the industry
they are operating in) should raise a red flag.
look at sales historically. Have quarterly and fiscal sales declined
on a steady basis? Or is the decline taking place in a quarter that
is known for such declines. The retail industry, as an example,
often gets a higher percentage of its sales during the fourth quarter
of the year than during the first quarter. The holiday season and
the return of merchandise after the first day of the New Year often
result in a drop-off in sales during most retailers' first quarters.
You should generally, however, be concerned if sales have declined
on a year-to-year basis and for the same periods. Smaller companies
are obviously affected more than larger companies.
also sometimes important to understand the difference between net
sales and gross sales.
While knowing the distinction is not always necessary, there are
often times that gross sales may not adequately reflect the revenue
from the operations of the firm. In fact, the recent trend of companies
reporting "pro forma" financial statements and their desire
to show their best side, through the use of these statements, has
caused many credit/financial executives to be much more cautious
when evaluating financial information.
the debtor's earnings declined, or if a loss was reported in the
most recent fiscal quarter or year, has the loss widened from the
same period one year earlier.
because a company reports a loss does not always mean that it is
on the verge of bankruptcy. Similar to what was discussed in declining
sales, if there is any decline or loss reported it must be compared
with the same period one year earlier.
industries have down periods and this should always be taken into
account. If it is a down period, how does it compare with the industry's
downturn--if there is one. If there is no industry downturn then
you should be concerned. If the company has experienced a loss during
this down period, does the loss come at a time when revenue has
declined as well. If the net loss for the period includes a significant
operating loss then you should be even more concerned. Many net
losses can be explained through sizable restructuring charges or
other nonrecurring charges. Operating losses, however, are a "horse
of a different color". Further, when you combine operational
losses with revenue declines of more than 10%--this should definitely
raise a red flag.
for companies that have operating losses or sizable net losses that
continue from quarter to quarter. Watch for companies whose net
losses are a sizable percent of sales.
have to be aware of the industry your debtor is operating in. In
biotech industries or in other technology firms, you may have losses
that are significantly higher than revenue. Using pharmaceutical
manufacturers as an example, these companies may be awaiting approval
from the FDA for a new drug. As such they could be expending money
that they obtained through public offerings or other financial backers--yet
they're reporting negligible or even zero revenues. In cases like
this, it does not always mean that the debtor is on the verge of
bankruptcy. What you need to know, in cases like this, is how strong
the financial backing is behind your debtor. You may be able to
obtain this information by contacting the debtor's primary lenders--whether
it be commercial finance companies, venture capital firms, traditional
lenders, etc. If the company you are dealing with needs your product
or services that badly, then the financial backers of your debtor
would want you to know that the company they are putting their money
into is solid AND will pay its suppliers.
there been a recent change in the debtor's management? If so how
severe? Has it been a wholesale exodus of top management?
is always a tough one to gauge. If the company has seen a lot of
its top management leave the company within a short period of time
you, as a supplier, should be concerned. You should be concerned
if the CEO has resigned. If the CFO has left the firm. If the COO
has left the company within the past quarter. If the company is
changing its board of directors. If management is leaving, for whatever
reason, you should be concerned.
If the CEO of twenty years, however, decides to resign for "personal
reasons" and the company is experiencing a slight downturn
similar to what it experienced in the past--don't jump the gun.
Investigate, investigate and investigate before thinking that the
CEO "jumped ship".
happening in your debtor's industry? Is it positive or negative?
is always an important one. The resent problems in the airline industry
and the recent terrorist attacks have caused not only many layoffs
within the industry but concerns among its thousands of suppliers.
Wholesale cutbacks are taking place throughout the industry and
beyond. Here's an example of why you have to understand industry
events and their "ripple affects".
company that sells to United Airlines comes to you with a new, sizable
order, look at it twice, look at it closely. Who were they getting
the products or services from previously? Why did they stop doing
business with that company? Was it because they were not paying
them and they are looking for new suppliers to also--not pay?
of not just the industry happenings but also of industries that
are cyclical. We mentioned retailing previously. We know that for
department stores and discount chains and even the big wholesale
clubs, the first quarter of the year is generally the worse for
that retailers specializing in selling durable goods (products that
will last more than 5 years) are generally hardest hit in an economic
downturn. However, keep in mind, there are times where one company
in an industry will rise to the occasion and beat an industry or
even an economic downturn. These often become the "shining
stars" of the industry. Be there with these companies. Often
they are the best managed and the most financially sound.
example is in the home improvement market. Home Depot started as
a small Georgia firm. Even during times of economic downturn it
still grew. It grew while many of its competitors were either in
bankruptcy or closing locations. Home Depot was a star in its industry
and nearly every industry has a star. Know who they are and why
they're successful and know the market that they are selling to.
a privately owned firm, with aging management, is there an automatic
succession plan in place?
one certainly requires your investigation skills and your knowledge
of the company. If a family-owned business, is the son or daughter
in line to succeed the father or mother? If so, what do you know
about these individuals. Have either son or daughter worked in the
firm? If so, how long? Does he have a solid reputation? In what
capacity did he or she work?
often, we hear of relatives taking over a business when the founder
retires and ends up running it into the ground. While this may not
be in the majority of cases, nevertheless to those of us that have
been stung by a bankruptcy filing or a liquidation when a relative
takes over the helm of the business we always ask ourselves why
we did not see it coming. Don't beat yourself up. It's not always
black and white.
privately held firms are family-owned. Some companies are owned
by a group of individuals that has not taken the company public.
It is important to evaluate these owners as well as the company's
management. Do they know the industry? How long have they been in
the industry? Are the people running the company venture capitalists
or financial people who may not know the industry as well as they
should? Have they hired qualified management? What is their background?
If a venture capital firm or another financial organization is backing
this privately held firm you are selling to or are considering selling
to, what is their track record?
Are they known for investing in a company and letting it grow or
are they known for investing in a company, letting it grow, and
then selling off the assets piece by piece?
often than not, however, when it comes to family-owned firms, a
succession plan is imperative--and this is something you should
ask for. Remember, you are acting as a bank by extending credit,
and any bank would want to have this information.
there been any layoffs at the company or are there any plans to
a company reduces its workforce most of the time it is a sign of
things to come. Granted when one company purchases or merges with
another company there are often duplication of jobs and as a result
the workforce is reduced according. This is for efficiency purposes.
However, when such a consolidation takes place it should not be
looked upon as "a bad thing". But when a company is having
problems and begins to reduce its workforce--even if by five percent--that's
something we should be concerned with. And when you combine industry
and company trends with the cutbacks, this might be a harbinger
of things to come.
quite often, before a company reports a loss they may announce anything
from temporary or permanent plant closings, the shutting down of
production lines, freezing salaries or even the laying off an unspecified
number of workers. As a result of these cutbacks the company may
report restructuring charges that result in losses.
cutbacks should be looked upon by creditors as an attempt by the
company to right itself or turn itself around. Any such move is
often an attempt to either return to profitability or minimize revenue,
earnings declines or even losses.
at any cutbacks at a debtor's operations with a cautious eye. It
may be a sign of things to come. But keep it all in perspective.
If a debtor simply wants to run its operation "leaner",
this could be a good thing. It could mean better cash flow and improved
earnings over time.
Is the company carrying to much debt? Has the company defaulted
on any of its debt or credit arrangements with its lenders?
are questions that often are difficult to obtain. The reason is
that many lenders will not report any defaults until that default
is about to take place. Of course, if a public company, the debtor
should be reporting their loan or credit line status on their quarterly
reports with the SEC. That's why it is imperative to stay on top
of a company's lending situation. Be aware of its overall debtload
as well as its debt capacity. Know how much the company can handle
based on its cash flow and other variables. Stay on top of whether
a company is meeting its debt obligations and living up to its credit/financing
arrangements with its lenders. Gathering this information may be
hard work but it can truly pay off down the road.
do not always provide easy access to the status of a debtor's financing
Often, the only way to be able to get this information is through
SEC filings (if a company is publicly-held). It is important to
remember that when you are extending credit, if you are a supplier
in any way, you are acting as a bank and your debtor's financial
arrangements is information you should have access to. Know when
the due dates are for any large/balloon payments. Know when the
arrangements expire. Know what percentage of credit lines have been
drawn down or even used up.
are an important supplier this information may be easier to come
by than if you are selling something of a lesser significance to
a debtor. Nevertheless, it is information that you should, as a
supplier, have access to.
How much of the debtor's credit line, with its bank and other lenders,
has it used up?
is an important one because it may determine how you get paid. If
a company s unable to pay its operational debt (or even long term
debt) through its internal cash flow it may be dipping into its
credit line arrangements with its lenders. You should know this.
Before this though, you should understand the debtors cash from
a historical perspective.
also important to know what, if any, form of negotiation is going
on between debtor and lender. What are the stages of those negotiations?
How long have they been going on? Are the purposes of the negotiations
to extend the debtor's outstanding credit line, to reduce it, to
increase it or "call it"? If it is for the purpose of
calling the credit line then you should find out if the debtor has
any or is working on obtaining any additional means of financing.
Who is the debtor working with? What is this potential lenders track
Analyze the debtor's cash flow historically. What are the trends?
Is it sufficient?
already talked about cash flow throughout this educational series.
It can never be overstated, however, the importance of analyzing
it and having a complete understanding of a company's cash flow
AND comparing it to industry standards. This is important as it
is directly tied to the company's profit margins as it affects its
operational earnings or losses as well as its net earnings or losses.
to completely understand a company's cash flow, however, you have
to understand the cyclical nature of both the industry and the company.
Are some months or quarters better for cash flow than others? Has
that historically been the case?
importantly is the cash flow sufficient to run the internal and
day-to-day operation of the company.
cash flow from a historical perspective as well as from an industry
one will go a long way to helping you notice the signals that a
company may display before becoming insolvent or having to file
a Chapter 11 petition.
Have any of the debtor's management ever been involved with a company
that has filed bankruptcy?
for this is obvious, however, be aware of the ease in which a company
can file bankruptcy and then, two months later, start up a new corporation.
Finding this out can be
difficult. That is why when you ask questions similar to this it
is important to have the debtor sign a truth-in-lending notice stating
(if this is a question on a credit application or other document)
that all the information provided is correct to the best of his
knowledge. Certainly, knowing if either the debtor personally filed
bankruptcy or was involved with a company that filed either Chapter
7 or Chapter 11 tells you a lot. How many debtors will be honest
with you is another story. If you ask them to explain the circumstances
under which the filing took place, however, you may get a higher
percentage to answer truthfully.
of the nation's top bankruptcy attorney's will tell you, it is not
unusual to find a company filing for bankruptcy protection only
to have its creditor's find out "after the fact " that
the principals of the now bankrupt firm are the same individuals
that were involved in a Chapter 11 or Chapter 7 filing several years
before. That's all the more reason to make certain that the information
you get on your credit application as well as through your credit
reports contain a thorough background check on the officers, directors
and stockholders of the company. If a company's stock is owned 100%
by one individual and you are shipping significant amounts to that
debtor, doing a thorough background check either through the credit
bureaus or through a private investigator may well pay off. While
a private investigator may charge anywhere from $500-$5,000 for
such a background check, if you are giving a customer net 30 day
terms on a $100,000 credit limit or more, then the investment for
that background check may be money well spent.
will go beyond checking what the credit bureaus or credit agencies
check out as they often work with local police departments and other
sources to make certain that there is no criminal activity by the
principals. They also search through such databases as Lexus-Nexus
to determine if any officers/ stockholders/principals were ever
involved in any illegal action, been sued, etc. Also, remember that
a high percentage of lawsuits are settled "out of court"
and may not show up on any credit report. A private investigator
may be able to find out such matters for you.
Is the debtor selling off assets? If so, which ones and why?
a debtor selling off certain assets may not always be a bad thing.
It is alwayssomething to watch for. If a company has decided to
concentrate on its core operations or
focus on what made it successful in the first place and it has decided
to sell off assets that do not relate to its core business, many
times this is a good thing--but not always. Keeping this in perspective,
along with the financial condition of the debtor gives you a more
firms unload certain assets which can be anything from machinery
and equipment to plants and operational divisions, to help reduce
its debtload. If this is the case, keep your ears and eyes open.
The next thing that might happen, if the debtor does not obtain
their asking price for the assets they are trying to sell or if
they cannot find a buyer--the next step may be filing for bankruptcy
for larger companies, investment bankers or other commercial finance
firms or merger and acquisition houses will be hired to either dispose
of certain assets or find buyers for them.
Be aware of who these outside brokers are and what their fees are.
Feel free to contact them to obtain as much information as possible.
Also, become familiar with the websites of the brokerages/investment
bankers or finance companies that may be involved in any such asset
sales. Surprisingly this often can give you a wealth of information.
the right questions and making use of some of the tips outlined
above, you may stay ahead of other creditors when it comes to noticing
the red flags that companies throw up prior to their filing for
information on any of your bankrupt accounts call the U.S. Business
Journal at 1-800-407-9044 and let them research this information
is furnished to you by the U.S. Business Journal and www.creditnews.com,
P.O. Box 5453, Evanston, Il 60204, 1-800-407-9044, 847-491-6331
(fax). The U.S. Business Journal is the oldest Daily E-Newspaper
that has been in business 20 years and exclusively reports on financially
troubled companies nationwide.