Credit Management CreditorWatch Payment Defaults Risk Management
5 mins read

Watch out for these 10 red flags of financial distress

When performing customer due diligence, what are the red flags to look out for? To mitigate credit risk, it is important to be able to identify risk indicators that highlight entities in financial distress.

Watch out for these warning signs that your trading partners may be experiencing cash flow problems. This information can empower you to act proactively and prevent bad debt.

1. Deteriorating payment behaviour

An entity’s payment times start to increase; its payment cycles become inconsistent and sluggish; they start failing to meet payment terms. The operators may begin to make constant excuses for late payments or try to avoid communication. These are early indicators that a business is struggling with cash flow.

Another red flag is if these entities demonstrate sudden dips in payment times (e.g. payment times suddenly drop to zero or one to two days). This could mean that suppliers have begun to cut them off and moved them to cash on delivery. Although it may look like they have started to pay their bills on time, they are probably experiencing serious financial issues.

2. Payment defaults

A payment default is a black mark on a credit report that indicates an entity has not paid its bills. A default can stay on a credit report for up to five years, affecting the entity’s credit score and reputation. Over 50 per cent of businesses that incur a payment default will go into administration within 18 months.

When a business is experiencing cash flow problems, it prioritises its larger critical suppliers and stops paying its smaller suppliers first. Initial defaults with smaller non-critical suppliers are a strong warning sign that an entity is in financial distress. If your debtor has stopped paying another supplier, it is likely they will stop paying you too.

3. Cross directorships

cross directorship occurs when an individual is found to be the director of multiple companies. When you’re working with a director with an adverse action registered against another one of their companies, you may eventually feel the adverse effects of that action. For instance, the director could be incurring debts on another entity, which could in turn affect their ability to fulfil your payments. They could also be shifting their assets around and engaging in illegal phoenix activity.

To mitigate this risk, it is important to understand exactly who you’re dealing with. Identify red flags such as directors with previously failed or failing companies or those with adverse information against them. Past and present director behaviour is a strong indicator of the future prospects of a business.

Did you know?

  • A director with a payment default is five times more likely to experience another one.
  • A director with a court action is two times as likely to have another one.
  • A director with a failed business is two times more likely to fail again.

4. Bankruptcies and personal insolvencies

A director or shareholder who has become personally insolvent can have a serious knock-on effect on any business they are involved in. Sometimes, bankrupt individuals slip through the cracks and remain as directors operating their companies illegally. Entering a relationship with these individuals could pose serious risks to your business.

5. Credit enquiries

If an entity is suddenly registering more credit enquiries, this could indicate that it is supplier hopping and unable to fulfil payments.

If it is getting multiple enquiries from finance companies, it could mean that it is applying for a lot of new credit or is unable to secure finance.

Watch out for an increase in credit enquires as this could indicate that the entity is financially unstable.

6. Mercantile enquiries 

These are companies with debt collection action against them.

More than 200 Australian debt collectors use CreditorWatch to conduct searches on non-paying companies. They can leave a mercantile enquiry which indicates the entity is being chased for an overdue debt. This provides an early warning sign that this entity is about to be taken to court.

If you see a mercantile enquiry on a credit profile, it is important to act immediately to get your goods or debt back before it goes through that court process.

7. Court actions

A court action may be lodged by a supplier or other creditor. When a court action is raised, it means that a Statement of Claim has been filed and a judgment has been made. Legally, that entity owes money and may be entering administration soon.

8. Winding up notices 

Winding up notices are issued by the ATO or creditors to enforce payment of outstanding debt. This is sent after failure to act upon a statutory demand. The aim is to find out whether the entity is solvent and able to repay its debts owed. If the entity does not act before the court date specified on the notice, the business will be wound up.

9. Insolvency notices 

Insolvency notices are published by ASIC announcing that a company has become insolvent. This is a notification to creditors, shareholders and the public about the entity’s financial instability or arrangements for it to cease trading.

An insolvent entity is unable to pay its debts when they are due and will soon enter administration and/or liquidation. Trading while insolvent is also illegal.

If your debtor has been issued an insolvency notice, act straightaway instead of waiting for the administrator to contact you. This allows you to get a head start on other creditors and significantly improves your chances of getting your money back.

10. Administration or liquidation appointments

When an administrator is appointed, company directors are relieved of their duties. The administrator investigates all available options for the company, determines the best path forward and provides a detailed report to creditors. The company may be restructured, get new owners or be wound up.

The liquidation of a company is the final stage – it cannot be saved and all its assets are sold to repay creditors. However, as a creditor, at this point, it is unlikely that you will get back everything you are owed. It is therefore important to recognise warning signs before your debtor gets to this stage. 

Gain a competitive edge with our exclusive data and insights

CreditorWatch is the most used credit bureau in Australia and offers the most comprehensive view of an entity’s credit risk. We have access to 50+ public and private data sources and even provide credit checks on unincorporated entities (i.e. sole traders, trusts and partnerships).

Our public data sources include Australian Securities and Investments Commission (ASIC), Australian Business Register (ABR), Australian courts, Australian Financial Security Authority (ASFA) and insolvency notices.

Our unique data includes payment defaults, mercantile enquiries, credit enquiries, transactional data, corporate ATB data, georisk and geodemographic data, and ATO tax default data.

We also have exclusive trade payment data from over 11 million monthly tradelines, derived from corporate ATB uploads and our Xero and MYOB integration. This reveals hidden insights into how a business pays its bills and is the most predictive indicator for future defaults and credit risk.

Where can you find this information? 

  • Credit Reports – An overview of key company and credit information
  • High Risk List – Entities that pose an immediate credit risk to your business; ordered in severity of risk
  • Risk Rating – Assess a business’s creditworthiness and predict its likelihood of default in the next 12 months
  • Payment Rating– Track a business’ payment habits over the last 12 months and compare it to the rest of the industry to identify slow paying businesses
  • DebtorLogic – Identify your customers’ payment trends across the market and determine their propensity to pay an outstanding amount.
  • Financial Risk Assessments – For credit and procurement managers to get an expert analysis on an entity’s financial performance.
  • Director Due Diligence – Find out about cross directorships, bankruptcies and other risks a director poses to your business
  • Business Risk Index (BRI) – Monthly insights into the financial health and insolvency risk of businesses across 300+ regions in Australia

CreditorWatch’s 24/7 automated monitoring service provides real-time alerts on any risky behaviour or adverse information about your trading partners. This enables you to make informed decisions about potential and existing customers and suppliers. Take timely action to mitigate credit risk, such as adjusting payment terms or using our debt collection tools to secure your cash flow.

If you’d like to learn more about identifying warning signs for your business, get in touch with us today.

creditrisk financial distress NewsHub paymentbehaviour paymentdefaults red flags toptips
Michael Pollack
Michael Pollack
Head of Content & Communications
Michael joined CreditorWatch as Head of Content and Communications in July 2021. He has more than 20 years’ experience in business journalism, marketing and communications strategy and digital content development. He is passionate about communicating to the business community how CreditorWatch’s product suite can help them grow and protect their companies.
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