It’s all a Question of Credit

Nick Forsyth Accountant EssexPosted by Nick Forsyth:

When I produce the Company Accounts, I often produce graphs of various ratios to discuss at the meeting, some of which would feature in the reports produced by Dun & Bradstreet, Credit Safe and Experian. Often these show a figure off trend and I might tell the clients that due to a large order received just before the year end, that the debtor days have increased and if a customer or supplier call you in the year to ask what has happened, this is the reason for it.

I’m pleased to say we don’t often have that call, but I have recently had more than one client call me saying that the credit rating that one of the three companies above, has provided them with a poor rating and they have had a call to ask questions. One of the clients got turned down for a substantial contract as a result.

As you can imagine I made some calls to identify why when comparing all three references, one should be much worse than the other two. Essentially it came down to the way in which their small company algorithm worked and I fancy that it would turn down the majority of SME’s for work, based upon the explanations I received.

“Your current creditors are large in comparison to the cash you hold” was one answer. “Yes,”  I replied, “but they have stock and debtors to more than cover these items and they get paid.” Essentially the algorithm says that all the debtors and all of the stock should be wiped out before taking considering the balance sheet. Now I cannot really believe that this is what is meant and suggested to me the Little Britain sketch where “the computer says NO” but I have to confess that in one of my ratios, I do discount the stock to arrive at what I call the 'acid ratio'.

Compare that to another report where you get 82 out of 100 rather than a score of less than 20. To me that’s rather serious and with it now not being an isolated case, I think we need to start considering the implications. Nearly all of us have been surprised by the failure of Carillion but talk to people in connected industries and they will tell you that it was a disaster waiting to happen or that they all knew they were not able to pay. On a recent technical course, we looked at the figures in some detail and saw a number of unusual accounting policies and items that were not being amortised propping up the balance sheet value.

Clearly the ramifications of this have been felt within the credit rating industry and ratio analysis has been firmed up producing some of the tough reports that I mentioned above. The trouble with this is that the obvious – to some in Carillion – may have implications for their own companies when they are quoting for contracts which they clearly won’t be expecting as “our balance sheet is in good shape.” And whilst we would agree, the algorithm won’t and therefore some contracts may go by the wayside.

Of course the agency concerned will accept interim accounts to assist in putting forward a counter-argument, but in my opinion it could further damage the rating after spending money to produce a balance sheet of the quality needed. Why? Because the level of profit needed to produce enough cash to cover the debtors and stock being provided for is not feasible in an interim period if the annual balance sheet could not do it. Such a turnaround would take a number of years against a short single period.

My biggest concern is that some of the biggest clients I have are still subject to the small company algorithm with the increase in thresholds, and as such are profitable and in no danger of business failure, even with a little choppy water. If they start to lose out on contracts as a result of an over harsh assessment, then that increases that danger substantially and puts contracts into the hands of larger companies - possibly the next Carillion!

If you have had issues with your credit rating then do please contact me to discuss as I think that this maybe something which our UK200Group network can discuss with the Credit Rating Agencies so that we can seek some improvement for the SME sector.      

May 2018

Disclaimer

The views expressed in this article are the personal views of the Author and other professionals may express different views. They may not be the views of Lambert Chapman LLP. The material in the article cannot and should not be considered as exhaustive. Professional advice should be sought in connection with any of the issues contained in the article and the implementation of any actions.

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