Why credit ratings don't tell the whole story

No salesperson ever lost their job by walking into their finance department with a credit report on their big new customer and saying, “their rating looks solid enough, let’s sign them up”.

But does the traditional credit rating tell the whole story and is it still the only measure of stability to use in this time of great uncertainty? Headline grabbing corporate failures over the course of time have all had a familiar theme:

• Company relies on its goodwill to retain a relatively healthy credit rating
• Suppliers continue to trade with the company relying on that rating
• Rumours of financial problems emerge late in the spiral towards failure
• Creditors get nervous and demand more financial cover
• The company starts to run out of liquidity and eventually fails
• Suppliers are left chasing administrators to get paid and wondering what went wrong

Sound familiar? A credit rating is a fabulous tool to show the current financial situation of a client or supplier on a given day. It provides an element of comfort that, on the balance of probabilities, your trading partners will ultimately pay you for services and goods rendered.

The reality in 2020, however, is that companies need an additional layer of insight and security to be confident in the ongoing stability of their key trading partners. At Plimsoll, we believe that corporate failure is predictable and having a long view of financial performance can protect you from surprises within your client database. Are any of your seemingly creditworthy key customers brewing up financial instabilities and how can you mitigate any potential failures?

The seeds of corporate failure are usually sown several years before a company ultimately fails. In fact, 9 out of 10 companies currently in administration were rated as Danger by Plimsoll up to 2 years prior to their demise. 24 months advance warning of looming trouble at a key client or supplier is valuable time to make the necessary contingencies for the worst-case scenario, especially if you are reliant on a small group of large accounts.

How does Plimsoll add value to the story told by a traditional credit rating?

Plimsoll provides a graphical, easy to understand assessment on any company. We plot a “financial health line” measuring the health and performance of your key customers, and alert you to looming problems in plenty of time for you to minimise the risk and build contingency into your plans.

Plimsoll recommends that companies complement customer credit ratings with a more in-depth assessment of near-term financial stability in the form of the Plimsoll Model. This proven predictor of company failure will let you spot:

• If a customer is getting the commercial success from recent investments
• If the company has overstretched and started to put pressure on profitability
• If profitability has fallen to such an extent that liquidity is dwindling
• If the business is overborrowed as it attempts to rebuild working capital
• If the company has passed the threshold from caution to danger

All these measures should be monitored on an ongoing basis. Plimsoll offers the most convenient and effective means of keeping a continuous eye on the stability of the companies you trade with. Used in conjunction with traditional credit ratings, you can avoid surprise when a customer fails. Better still, you can reduce your exposure long before their demise and build a list of other accounts you should be chasing now.

For more information about Plimsoll and how we can help you to keep a closer eye on the customers that matter to you, visit www.plimsoll.co.uk