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Published Articles by David Balovich

Title: Credit Investigation
Published in: Creditworhty News
Date: 6/10/08
Today’s business environment is rampant with mergers, acquisitions and re-organizations. More and more businesses are being acquired by investment organizations and are then merged and consolidated with other acquisitions. The majority of existing customers within a creditors’ portfolio are no longer the same legal entity they were when credit was originally established. The ultimate responsibility for the establishment of customer accounts and lines of credit still rests with the credit professional regardless of third party firms and the NACMs’ continued promotion to outsource this basic function of credit management. It is essential that guidelines for performing this necessary procedure be established and followed. Customers must be identified with their correct legal name and address. Additional identifiers may include a customer number, a Social Security or corporation identification number, etc. for fast, accurate and easy identification. If customer orders are to be reviewed prior to credit approval, it is necessary to describe in a procedural document for the benefit of all company employees, not just the sales and credit personnel, what the parameters are for credit authorization.

Sales-Supplied Information

Generally, sales representatives are the company's first contact with a new customer and the most frequent contact with an established customer. Sales should always be looked to as a primary source of credit information. While some salespeople may not be suited by temperament, interest, or experience, and may feel imposed upon when asked to perform credit or collection functions, they nevertheless must be made aware of how important they are to the process of credit extension and the ultimate profitability of the organization.

Often sales personnel are provided with blank credit application forms to be left with the customer to complete and mail directly to the credit department. Frequently, however, it is desirable to have sales representatives send in the completed form. Also, without asking questions, sales representatives can obtain a great deal of information by keeping their eyes and ears open to benefit not only the sales and marketing functions; but, to enhance the credit partnership as well. Sales personnel are in an excellent position to comment on the location and appearance of the customers’ place of business and the presence or absence of competition. They can observe the names of other brands and products inventoried and the personalities and demeanor of both employees and management. To obtain the full benefit of the sales representatives' observations, a spirit of mutual confidence and cooperation must be maintained between the sales and credit departments.

Customer-Supplied Information

There is no better source of information about a business than the business itself. Direct contact with the principals provides the credit professional with financial details, bank and trade references, and other information of importance. How this information is requested and obtained will depend upon the time allocated for the investigation, the location of the customer, the relative risk of the credit exposure, and the degree of cooperation that can be obtained from the customer.

The Credit Agreement

Within the credit agreement there is necessary and optional information the credit department relies on. The necessary information includes:

  1. Date of application
  2. Customer bill to name, street, city, state, zip
  3. Customer ship to name, street, city, state, zip (no post office boxes)
  4. Owners legal name (can be an individual, group or another company)
  5. Essential telephone numbers (purchasing, sales, payables)
  6. Legal characteristic -- sole ownership, partnership, corporation, llc or other
  7. Type of business -- distributor, retailer, wholesaler
  8. Year business started
  9. Year business incorporated -- if applicable
  10. Year of current ownership
  11. Trade references (most recent statement) and phone number
  12. Does the subject rent or own premises
  13. Include a statement asking for sales and use tax exemption (resale certificate) to be mailed with the agreement
  14. (For proprietorship) ask for the owner's social security # and a "signature/date block" asking their permission to order a personal credit report
  15. Request a blank copy of the customer's purchase order (front & back). 

The optional information

  1. How much credit is requested
  2. Any buying group affiliation
  3. Branch operations and listings (include names of authorized purchasers)
  4. Contact name: buyer and accounts payable manager
  5. Salesperson's comments: competitive brands; condition of business (exterior/interior); condition of inventory; promotional practices, location- rural, suburb, city; description of premises
  6. E-mail address
  7. Fax number

Who is the Customer?

Upon receiving the credit agreement / application the first order of business should be to verify the business entity. By doing so we determine the correct legal name and whether we are dealing with a corporation or individuals. We can contact the corporations division of the state where the business is located either by telephone or through the Internet to ascertain this information. If the business is a corporation or limited liability company we will also want to obtain the following information.

1.     Date of incorporation

2.     State of incorporation

3.     Name & address of registered agent

4.     Officers names

5.     Status of corporation; active, in-active, good standing or not

6.     Name of incorporator(s)

Credit References

One of the most important questions we should want to know about the other vendors the customer is doing business with is who may have a security interest in our products and the proceeds from the sale of our products. This information can be determined by conducting what is known as a UCC search or a search of the Uniform Commercial Code. The importance of knowing what state a business is incorporated in is to know in what state to search for secured creditors. We should always want to contact the secured creditors to find out how they are being paid.

Information we want from a reference

  1. Verification of subject name and address
  2. Highest amount of credit extended to the subject
  3. How long have they been dealing with the subject
  4. Amount currently owed
  5. Amount past due
  6. Payment trend of the subject
  7. Date of last purchase (especially valuable when calling a supplier in our same product line)
  8. Terms by which the customer is being sold *
  9. Any NSF checks
  10. Any excessive deductions or return of product

* "Terms" are a very sensitive topic relative to credit reference information. Some corporate counsels instruct employees never to discuss terms when requesting or giving references. We should seek advice from our company's legal sources to ensure consistent compliance with company policy.

References become valuable when other sources (industry groups) lack sufficient background information.

Although Character is considered to be an important aspect of the business credit decision, in most instances, credit analysts do not actually appraise character--but rather the reflection of character as revealed by reputation and references.

The easier a form is to fill out, the more likely it will be completed and returned to the credit department. When sending out a written request for information, always include an addressed return envelope with affixed postage.

When making a phone reference, make sure to get the person's name and make sure the information taken over the phone contains the date the information was provided.

Financial Statements

It is good practice to ask the customer for their last two fiscal year end financial statements. However, unless dealing with a publicly held concern it is sometimes difficult to obtain financial information. The reason is that financial statements include both balance sheet and operating statements and often companies do not want to provide the information appearing on their statement of operations. As creditors, we are primarily interested in liquidity and leverage that gives us the assurance that the customer can pay our invoices within our terms. The information we are seeking is most often found on the balance sheet not the operating statement. We suggest asking for the balance sheet rather than a financial statement to achieve success in obtaining the information desired.  

Generally, a customer that makes a complete financial disclosure is treated more favorably and that should be communicated when making the request for financial information. Financial statements can be used as a means of classifying customers into risk categories. The initial financial statement should always be retained so it can serve as the benchmark for future comparative analysis. The extent of our credit exposure and/or the importance of our product or service, may dictate the degree of financial information we require and receive. Always save the envelope associated with the financial report as verification of when it was sent and how it was received. If the statement is discovered to be fraudulent, and it has been used as a basis for credit extension, the envelope becomes proof that fraudulent information was sent through the mail. Be wary of estimated statements or financial statements in round numbers. Make sure the statement is dated and signed by the owner (if from an accountant, it should be on the accountants stationary and signed by a member of the accounting firm). If an accountant's opinion or cover letter accompanies the statement, make sure the firm signs it. Consider comparing the customer’s financial statements to similar customers (same SIC code and sales volume) to determine the subject’s strengths and weaknesses to the industry norms

Credit Reports

There are four types of commercial sources of credit information

  1. General commercial agency business report, such as the Experian or Equifax Business Information Report
  2. Payment experience and trend analysis reports as provided by the National Association of Credit Management or Risk Management Association
  3. Specialized reports on businesses in a particular industry as provided by firms like Reimers.
  4. Trade group interchange reports.

Purpose and scope of these reports

  1. Identification information of the business (where applicable, cross-check with application):
    1. Name
    2. Address
    3. Telephone number
    4. Principal owner or Chief Executive Officer
    5. Standard Industrial Classification code (to assist in classifying our customer base)
  2. Agency rating
  3. Agency credit line recommendations
  4. Development of special events
  5. Payment habits
  6. Financial information including facts and trends
  7. Banking information
  8. Historical information on principals
  9. Operational information

Is the New Customer a Fraud?

The essential characteristic of fraud is the intent to deceive.

What to look for on the credit application:

  1. Bill to or ship to name that "rings a bell" as a suspect business
  2. Principal's name that "rings a bell" as being suspect
  3. Look for discrepancies among the various "tools" we have available (credit application, credit agency report, banking information, trade reference data)
    1. Name consistency
    2. Address consistency
    3. Phone number consistency
    4. Principal's name consistency
  4. Look for unusually high opening orders inconsistent with other data about the customer
  5. Be suspect of billing and shipping to different locations for small businesses
  6. Look for familiar references
  7. Be suspect of various unfamiliar references
  8. Take note of unsolicited orders -- particularly from trade shows

New customers represent an opportunity for increased sales and profits while existing customers provide continuity and allow us to expand into new markets and territories. However, certain procedures must be followed before a prudent credit decision can be made on either. Change is a constant and we cannot allow ourselves the luxury of becoming comfortable with our customer portfolios. Credit investigation should always be a continual work in progress. Whenever we encounter a change with the customer, whether it be an inquiry from a new vendor, a change of address, a management change, etc. That is the time we should pick up the customer file and begin updating the customer information.

I wish you well

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