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Before You Sign on the Dotted Line: 4 Types of Companies that Need a Business Credit Check

Here are four types of businesses on which you should conduct financial due diligence before signing on the dotted line.

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3. Small Business Customers

Some businesses may find it helpful to run a business credit report for a major customer, too. “If your customer goes out of business that could be very problematic,” Cole says. “First of all, you lose sales, but more importantly, you may have accounts receivable outstanding. They may not be able to pay you back.”

“It doesn’t really matter which side of the supply chain they’re on – whether they’re a customer or a supplier. If they go under, they directly impact your ability to supply your goods and services and make money,” Cole says.

4. Your Own Small Business

When a company is evaluating its own financial health and planning for growth or for weathering a downturn, an assessment of your current situation and probability of default helps create a more complete picture.

The same is true for a company that is considering applying for a loan. Knowing your own business credit rating prepares you for potential objections on the part of a lender and can build credibility as you negotiate on rates and fees. Lower rates and fees mean higher profits for you.

When banks assess potential borrowers, they fundamentally are examining the ability of a potential borrower to repay the loan. Analyzing the potential borrower’s assets, as well as the cash-flow outlook and potential pitfalls are primary objectives.

Companies that have business credit ratings and understand their own default risk can also use that information in negotiations with other businesses. Similarly, deals involving mergers or asset purchases may be better informed with information on how likely it is the counter party will default within a year.

Evaluating Future Business Credit Risk

Some people might find it advantageous to evaluate a business’s probability of default not only before entering into a business relationship, but also periodically thereafter.

Experts say that a company’s probability of default can vary by stages of the business cycle and by stages of an industry lifecycle.

For example, retailers can run into cash crunches when they must purchase large quantities of goods ahead of the holiday season, which is typically their biggest revenue-generating quarter. Reassessing business credit risk is also a good idea when there are signs a business partner has experienced a change in financing or is facing a hardship. For instance, a business partner’s suppliers are suddenly accepting cash only for deliveries, it may be a good time to reassess default risk in order to protect your ability to recover accounts receivable.

Connect with Sageworks, Inc. on Twitter @SageworksData.

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Photo Credit: Mango

Endnotes: 1 “Sageworks Private Company Indicator.” SageworksInc.com. Sageworks, Inc. Web. Accessed 8/19/12. http://www.sageworksinc.com/private-company-indicator.aspx. 2 “Private Company Services Trendsetter Barometer: Business outlook report, Summer 2012.” PWC.com. PricewaterhouseCoopersLLP. Web. Accessed 8/17/12. http://www.pwc.com/en_US/us/private-company-services/publications/assets/pwc-trendsetter-barometer-business-outlook-summer-2012.pdf.

Mary Ellen Biery is a research specialist at Sageworks, a software company that develops software for financial professionals and small businesses. Biery is a veteran financial reporter whose works have appeared in The Wall Street Journal, Dow Jones Newswires, CNN.com, MarketWatch.com, CNBC.com, and other sites.

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