When he asks prospective customers for bank references, Larry O'Brien, CCE, also asks that they call or write their bankers to let them know he'll be calling and to authorize them to release information to him.

"Without knowing the banker's name and having your customer authorize information release, you often end up in the bookkeeping department with a clerk who is not familiar with the account," points out O'Brien, who is manager, Division Credit, for IMC-Agrico Co. (Bannockburn, IL).

O'Brien also wants audited financial statements for the last three or more years, and with these he typically looks first at the "notes" at the end of each statement. "This gives you valuable and detailed information on what has taken place in the customer's company during the last year," he notes. "For example, you can find information on any contingencies the company might have or lawsuits that could pose a problem down the road." He then scrutinizes the following:

1. The cash flow statement. "This tells you whether the company is currently generating cash from its operation. If this is a negative number, then you will want to see how they are making up the shortfall--whether it's through bank financing or selling assets in order to remain afloat."

2. The balance sheet and income statement. O'Brien recommends "spreading" this information on a PC spreadsheet in order to conduct ratio analyses. Here are some of the more important ratios to look at:

   • Liquidity ratios: payables deferral period, current ratio, and quick ratio.

   • Asset management ratios: inventory carrying period, fixed asset turnover, and DSO.

   • Debt management ratios: times interest earned, and debt to equity.

   • Profitability ratios: profit margin, return on assets, and return on equity.

Once you elect to do business with a customer, O'Brien recommends continuing to get updated copies of financial statements in order to stay abreast of their trends. "Over the long term, even stable customers can eventually get into trouble," he explains.

And while effective credit analysis helps you stay away from problem accounts, he notes that it is still important to keep up on collection activity. Credit and collection professionals at IMC-Agrico are very vigilant in this area. "We follow up on past dues very quickly," he emphasizes. "If an account is a week past due, we call to see what the problem is."

Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006.