Bill Chepell | Chicago, Illinois

Sound Credit Practices

The following 4 items are prudent credit practices if you have potential concerns with clients.  Outside of (3), they do not require much work.

1) Validate the auditor – Applicable if there is a financing arrangement and you receive the audited financial statements. Of course, verify the auditor’s opinion letter expresses an unqualified opinion.  Yet also, if you have not heard of the auditor, verify the auditor’s good standing.  After the accounting scandals in the early 2000’s, Sarbanes-Oxley established the PCAOB (Public Company Accounting Oversight Board) as the regulator  overseeing audit firms. If a firm audits a public company or a FINRA registered broker-dealer, the firm must file with the PCAOB.  The PCAOB performs inspections on audit firms generally once per every 3 years.


2) Quarterly covenant compliance – request a copy of your customer’s most recent signed quarterly covenant compliance verification form.  Banks often include financial covenants within the lending agreement terms of their working capital lines of credit which restrict leverage and maintain an equity capital level.  On a quarterly basis, they will require the borrowing customer to verify its adherence with these financial covenants.  The official verification is in the form of a certificate which a financial executive signs to verify.  This is typically required by banks on a quarterly basis.  Additionally, Banks will require to receive it within a specified time after quarter end, typically 20-30 days.


3) Monitor market data / quarterly earnings – Although this requires setting up web data feeds and formatting reports, it could become a valuable tool which could easily be adjusted for various customers or industries. You can rely on news reports, but this provides a comprehensive view. 


4) Understand preferential transfers– Preferential transfer means that despite payment from a distressed customer, the creditor must return the payment if received within 90 days prior to a bankruptcy filing.  The justification for this law is the view that a debtor paying off a particular creditor or group of creditors results in other creditors getting less in the bankruptcy.

How should you proceed with a distressed customer? First, requiring advance payment or COD is the best option when selling to troubled customers.  Once credit terms are extended, federal bankruptcy law including the preferential transfer rule applies.  Second, if some form of credit terms is required for the customer, consistency is important.  When late payments occur, you should not engage in collection practices which are unique compared with other customers or the industry overall.  If a sale is lucrative, consider consulting an attorney if a troubled company is insisting on credit terms.