By Mel Zwaig and Michelle Picket of MSI specialist member firm Zwaig Consulting Inc. of Toronto, Canada.

As a follow-up to their article 'Early Warning Signs', Melvin C. Zwaig and Michelle Pickett of Zwaig Consulting Inc., draw attention to the non-financial indicators which may signal a customer's pending financial difficulties.

With 80% of North American companies being privately-held, financial information is often not available and credit grantors must rely on non-financial information in order to make their credit decisions. Without the use of financial parameters or ratios how can these professionals evaluate the solvency of their customers? Early detection of non-financial indicators of financial problems can lead to a happy ending for all concerned. These indicators fall into the following categories: Payment patterns, purchasing patterns, industry trends, new developments, lawsuits, personal problems, and the rumour mill.

Payment patterns
Companies typically pay invoices on a regular, albeit sometimes tardy basis. Any change in this pattern should be a red flag to creditors and could be an indicator of financial and cash flow problems. These changes include a company no longer taking advantage of discount terms or a company extending its payment terms. For example, in the fall of 1996 privately held T. Eaton Company Ltd. extended its standard 75 day payment terms. The Company filed for Protection under the Canadian Companies Arrangement Act ("CCAA") in February 1997.

Purchasing patterns
Are your customers' orders increasing or decreasing? A decrease in purchases may indicate that a customer's sales are declining or that the customer has found another supplier. If a customer has reached its credit limit and the account is overdue, a decrease in purchases may suggest that the customer is unable to meet its liabilities and is unfortunately increasing its credit by purchasing from another supplier. Is your customer purchasing a higher number of smaller orders? This could indicate that a customer does not have sufficient cash flow to pay for larger orders. A sudden increase in purchases is also suspicious if there is no evidence that the customer is experiencing an increase in business. The customer may be stockpiling inventory prior to a court restructuring.

Industry trends
What are the industry trends and how do they affect your customer? Have technological advances negatively impacted your customer? Is your customer in danger of losing market share due to new technology? Are your customers adversely impacted by changes in the industry or the economy in general? The automotive industry is one of the primary customers of the steel mills. A downturn in automotive sales will impact not only on the automotive industry, but will also have a domino effect on their suppliers, whether they are original equipment manufacturers, second tier suppliers, or the after market manufacturers, as well as adversely affect businesses in the surrounding areas.

Continuing with the steel industry analogy, companies must be aware of the impact of imports and dumping on its customers. Essentially, companies need to know their customer portfolios and must be able to pinpoint their weaker customers. These customers will be the ones most deeply effected by an adverse change in the industry. These are the customers that companies need to monitor closely and where necessary cull from their portfolio.

New developments
How well do you know your customer? Where is your customer located? Has a strong competitor recently moved into your customer's territory? The advent of 'Big Box' stores has eliminated many local and weaker national companies. We have all seen the impact of Home Depot, Wal-mart and Chapters on weaker competitors. Being aware of such a development will enable a credit grantor to proactively deal with the situation and determine whether it continues to support this customer.

Law suits
Is your customer the defendant in a major lawsuit or a large number of lawsuits? How ow would the How would the loss of such a lawsuit impact on your customers' business? Many companies such as Dow Corning Corporation and Texaco Inc. filed for court protection following a large judgement against them relating to some litigation. Credit reports from credit information providers such as Equifax provide a list of outstanding litigation, giving a 'heads up' to credit grantors.

Personal problems
Is your customer experiencing personal problems? Is the owner or majority shareholder involved in a divorce? Is the owner experiencing health problems? Is there a succession plan? Owners or key personnel may be distracted by personal problems and lose focus on the business. An owner may be forced to give up a share of his business in the event of a divorce or incur additional debt in order to make a lump sum payment to a spouse. Either of these events may adversely impact on a business. Being aware of such matters would enable a credit grantor to closely monitor a customer's account for signs of deterioration.

Rumour mill
The old adage "where there is smoke there is fire" typically bears true. If there are rumours that a customer is experiencing financial difficulties or cash flow problems, there is probably some truth to the rumours. A credit grantor would be wise to investigate the rumours and monitor the account closely.

Third party endorsement
Credit grantors can use credit reports or bank reports as a source of non-financial information on its customers. These reports provide trade payment information, the number of years in business and other relevant information. Some of these agencies also offer monitoring services, which could assist credit grantors in detecting any financial deterioration in their customers.

Summary
Current financial information is the best indicator of commercial distress. However, when financial information is not available, a credit grantor must rely on other information as a bellwether of customer problems. Customer and industry knowledge are important non-financial data, which a credit grantor can use to detect impending financial problems.

About the author
Mel Zwaig is CEO of Zwaig Consulting Inc. in Toronto, Canada, a leading financial management consulting firm. Mel was president of Arthur Anderson, Inc., Canada for 11 years.