More than three years after the official end to the recession, considered the worst since the Great Depression, U.S. businesses are recovering but not recovered.
Privately held companies in the U.S. are generating average annual sales growth of around 6 percent, and profit margins on average are at a five year high. The Dow Jones Industrial Average of major, publicly traded U.S. companies recently traded at a five-year high, and the U.S. economy continues to post positive – if small – gains.
But uncertainty remains the mood of the day, with surveys showing that a sizable portion of private companies are worried that a potential lack of demand is the top barrier to growth. Business owners must protect themselves against financial and operational risks, even as they balance the need to service customers and plan for growth.
When should your business conduct financial due diligence on another company?
Sageworks Senior Financial Analyst Michael Lubansky says, “Most companies at some point could find it useful to understand another company’s probability of default. A common situation where businesses desire more information on credit risk is when they are evaluating a new vendor or supplier. Evaluating the default risk before entering a contract can boost business safety by perhaps avoiding supply-chain interruptions.”
Here are four types of businesses on which you should conduct financial due diligence and perform a business credit check before signing on the dotted line:
1. Small Business Suppliers
“If you’re depending on a company to provide the supplies you need for your business operations, and if the supplier is not financially sound, you potentially expose yourself to problems that may slow your own business operations,” according to Lubansky. This could result in a shortage of raw materials or inventory, making it difficult to supply your customers.
DePaul University Professor of Finance Rebel Cole adds that in addition to affecting your ability to generate revenue, a supplier going out of business can also affect your cash needs. “They may be offering you trade credit and therefore you could be losing one of your sources of financing,” he says.
2. Small Business Vendors
Vendors or distributors of your own products can potentially create business risk on several fronts that warrant vendor credit checks. “There’s reputational risk if a vendor or someone who is selling your product is not financially sound,” Lubansky says. “That could reflect poorly on you as a business operation.”
Additionally, if a vendor defaults you may have to identify another vendor so that your products can continue to be sold and distributed. This risk can lead to lost revenue and sales channels.