All Hands on Deck: Steadying Your Credit Amid the COVID-19 Pandemic

Leighton Weston of Creditsafe provides a forecast for the factoring industry and explains why it is important for factors to understand their exposure and their customers’ credit risks to successfully navigate through the COVID-19 pandemic and its aftermath.

BY LEIGHTON WESTON

The COVID-19 pandemic has rocked the economy so severely that no one knows when the negative consequences will end. What is certain is that some businesses will close and never reopen, in part because of a cascade of defaults among their supply chains or clients.

My company, Creditsafe, recently found that 26% of U.S. businesses face a high risk of failure as they struggle to pay their suppliers. Companies are making payments 50 days beyond terms (DBT), which not only hurts their credit and relationships but also strains their suppliers’ cash flows and ability to stay open. Additionally, we have tracked a 35% increase in payment defaults between March and April, which coincides with a 46% increase in defaults year over year.

Unfortunately, it appears that the situation may only get worse. During the initial phase of the crisis, many businesses had enough cash to continue shipping in the short term. But as the pandemic stretches on, businesses are running out of money; in turn, suppliers cannot cover the costs of their essential needs. As the unemployment rate — which is already at historic levels — continues to rise, more consumers will stop buying non-essentials and further weaken the economy. We’ve already seen giants fall because of this, including J. Crew and Neiman Marcus, which recently filed for bankruptcy.

During the 2008 financial crisis, businesses scrambled to increase cash flow even as consumer spending dropped. Some companies closed, while others retooled the aspects of their businesses that had become irrelevant. Those that were willing to adapt made it through that crisis, and many of the companies that apply those same lessons will survive this crisis — provided they have the right perspective and path forward.

THE FACTORING FORECAST

One of the major differences between the 2008 and 2020 crises is that the economy collapsed during the former and caused people to lose everything. People are still spending today, although their priorities have shifted. Certain verticals are expanding and others are shutting down. The key to surviving at this moment is to seek opportunities within those expansions.

We’ve seen payments accelerating in certain sectors, such as the food industry, and the demand for food retail has made those payments even faster. Consumers are spending at their local stores and that cash is quickly distributed throughout the supply chain. Clients and suppliers are actually paying faster and more often because of the crisis.

What does this all mean for factoring companies? It depends on your exposure. Companies that deal with staffing clients and businesses involved in transporting goods and materials can expect continued heavy activity. Those that work with the retail sector may see a mixed situation. Industries like food retail will remain essential and profitable, but other retail areas could lag if the economy does not bounce back quickly.

As a result, factoring companies need to assess not only their standard credit risks with clients but also their clients’ risks in relation to the pandemic. For instance, small businesses will depend on credit and loans to continue paying staff members and maintaining inventory. Loans and credit are in shorter supply than they were pre-pandemic, however, which could cause small business clients to struggle. Meanwhile, companies that depend on suppliers in other countries could face production slowdowns that cause them to pay up to 90 days beyond their agreed upon terms.

Given these concerns, leaders in the factoring industry should use the following steps to develop a strategy for whatever lies ahead:

1. Understand your exposure. Analyze your entire book of business and identify potential negative outcomes for your company. Run different scenarios and consider how they might affect your operations going forward, including if there are further downturns due to the pandemic.

You also might consider a fault tree analysis, which you can use to define your goals and then consider the actions that might lead you to the opposite outcome. You also can analyze past incidents, such as problems caused by the first wave of the crisis, to strategize how to be better prepared for the next big shift.

2. Benchmark customers’ credit risks. Once you’ve assessed your company’s risk, turn your attention to your clients. What is their normal credit exposure versus their pandemic exposure? Analyze their industries, size of business, operation locations and historical credit data.

Recall that certain verticals are flourishing while others are struggling. You need to know how many of your clients fit into each category to anticipate where you may see payment delays or defaults — and where you can expect faster payments than usual, too.

3. Prioritize clients by risk. Now is the time to take stock of your clients and decide which relationships you want to maintain. If one of your clients is a dance studio in Manhattan and another is a medical supply company in Los Angeles, you’re going to look at them very differently. The dance studio is going to have a higher chance of late payment and default, so you will want to direct more resources toward the medical supply business.

If a client is high-risk at the best of times, you may want to let that relationship go in favor of those that are more stable; these considerations are even more important during these challenging times. Once you’ve made those decisions, outline a plan for what your prioritization will look like as well as what procedures you’re going to put in place for dealing with different clients.

What matters most is constantly monitoring the clients and industries you serve. Restaurants were struggling early in the pandemic, but they may pick up steam as stay-athome orders are lifted. Different industries will recover at different rates, depending on where in the country (or the world) each client is located. Ongoing analysis will be the key to assessing risk accurately and deciding which clients you want to continue to serve.

Leighton Weston is the global account director with Creditsafe, which offers comprehensive and accurate financial information on more than 330 million businesses worldwide.