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Financial Problems; Red Flags; Signs of Financial Distress or Elevated Risk
There are a number of events that should trigger a credit analyst to look more closely at the risk of extending credit to a customer. Among these red flags are:
- A deterioration in the customer's cash position;
- A bounced check;
- High levels of debt;
- A slowdown in the receivables collection period;
- Higher inventory levels;
- Inadequate inventory levels to meet sales demand;
- A slowdown in inventory turnover;
- Changes in the customer’s credit and sales philosophy;
- A sharp increase in the dollar amount of accounts receivable;
- A sharp rise in accounts payable;
- Higher DSO;
- Broken payment commitments;
- A change in personnel in the debtor company;
- Loss of key personnel;
- A layoff at the debtor company;
- A decline in current assets as a % of total assets;
- Re-valuation of fixed assets for the purpose of improving the balance sheet;
- Losses, or a declining profit margin;
- A decision to sell merchandise below cost;
- Lower returns on sales;
- Lower gross margins;
- Lower sales;
- A loss of market share;
- Low working capital level;
- The existence of heavy liens on assets;
- One or more lawsuits filed by trade creditors;
- One or more creditors placing the debtor company for collection;
- A high concentration of intangible assets;
- A decrease in current assets;
- A decrease in liquid assets;
- A disproportionate increases in current debt relative to current assets;
- Negative working capital;
- A narrowing current ratio;
- A low quick ratio;
- A high debt to equity ratio;
- Negative equity;
- Negative tangible net worth;
- A substantial increases in long-term debt;
- A high debt to capital relationship;
- A major gap between gross and net sales;
- Rising costs as a percent of sales;
- Falling profits;
- Rising levels of bad debt losses;
- Mismanagement;
- Significant changes in the balance sheet structure.
This list is not intended to be comprehensive. These are just examples of activities that should trigger interest on the part of a creditor company in the debtor and in its creditworthiness
Edited by Michael C. Dennis. Mr. Dennis is a business consultant and can be reached by email at mcdennis13@yahoo.com