Keith McLaughlin: "The arrears creep up, and you don't want to be used as a free bank." Photo / Supplied
Businesses have faced two years of uncertainty since Covid-19 struck and it's become increasingly important to know who they are dealing with. A credit check makes sense.
Keith McLaughlin, managing director of credit reporting bureau Centrix, says a crucial element of business sustainability is protecting cash flow and ensuring customers and suppliers are reliable.
"Small and medium-sized business owners need as much certainty as they can get when it comes to customer and supplier partnerships — both short and long term. Will they be able to honour agreed payment terms?"
Centrix's latest insights report revealed small business credit ratings or scores across all industries fell during last year. McLaughlin says there were variations in default risk — with higher levels of defaults in rental/property, transportation, retail and construction sectors, and lower defaults for information services, education and arts, and professional services.
"A simple and cost-effective way of assessing the risk of non-payment is to credit check prospective partners," McLaughlin says. "Understanding their credit score, debt levels, defaults, repayment behaviour and any other financial red flags can help business owners make informed credit and lending decisions.
"Running credit checks can help set appropriate terms of trade for each new customer. Credit checks on potential suppliers can also help secure the supply chain and reduce operational risk."
McLaughlin says if the credit check shows the customer pays on time, this provides a degree of confidence for the business. But if the check shows a pattern of paying after 65, 80 or 90 days, this late payment can strangle the cash flow of a business.
"The arrears creep up, and you don't want to be used as a free bank. Things are not quite the same as they were.
"If a business had a bad debt or a series of bad payers, it could borrow itself to get over the difficult period. But that's more difficult to do now."
A credit check showing a low score with a high risk of defaulting on payments means a business can negotiate favourable payment terms that require pre-payment or cash on delivery, McLaughlin says.
Centrix, based in Auckland with 30 staff, is one of four consumer and company credit reporting agencies in the country.
Over the past 13 years, Centrix has collected, analysed and collated the financial status of every consumer in New Zealand over the age of 18, receiving data on a monthly basis from 71 clients including all the banks, telcos and electricity, water and gas providers.
The credit reports are scored between one (very high risk) and 1000 (very low risk) and disclose any credit defaults, District Court judgments, and insolvencies/debt repayment orders.
A score of more than 892 is deemed excellent — accounting for 20 per cent of New Zealand's population — and Centrix suggests "you should be eligible for the best credit cards, loans and utility services (but there are no guarantees)."
A score of 496 to 705, involving 20 per cent of the population, is rated fair and there will be additional conditions attached to credit cards, loans and utility services.
Ten per cent of the population is ranked between one and 495 or rated poor, and Centrix says in the report: "You're more likely to be rejected for most credit cards, loans and utility services."
McLaughlin says people are managing credit better than they were three years ago, and lenders are being more responsible.
"We hold more information, and we can pass this on to lenders who can make smarter decisions."
Centrix added company reporting to its consumer credit services over the past six months, and that side of the business is growing. "There's more demand and awareness in the marketplace for credit checks," says McLaughlin.
"Businesses are even doing checks on themselves. They may be going to a bank for a loan, and they want to be happy about what they see on their credit history. It makes life easier in these days of responsible lending and the new Credit Contracts and Consumer Finance Act (CCCFA).
"The act which demands more disclosure has put more tension in the lending market.
"There is a far greater obligation on lenders to satisfy themselves that borrowers can meet the repayments. Before, lenders could rely on the information provided by borrowers. The flexibility has been taken out," McLaughlin said.
Amongst the prescriptive regulations, lenders have to look at a borrower's financial situation in a high degree of detail including criteria for estimating and verifying a borrower's income and expenses.
The regulations, which came into force on December 1, were soon criticised for their complexity and creating significant uncertainty for lenders.
The Government is now reviewing the unintended consequences of the act.
McLaughlin says the year started with overall weaker consumer credit demand, falling 14 per cent year on year.
A combination of weakening consumer and business confidence, rising interest rates and changes to the CCCFA are having an impact.
The proportion of mortgage loan applications successfully converted into new home loans reduced from 39 per cent in October to 27 per cent, a fall of nearly a third.
McLaughlin says "we are also seeing this impact other consumer finance products, including credit cards, auto finance and personal loans.
"Successful loan conversions reduced from 35 per cent in October to 25 per cent in January."
In its January Outlook report, Centrix asked the question: Are we facing the next great credit crunch?
Small business credit demand was up 9 per cent year on year — with the construction sector remaining buoyant — but the average score for new credit applications hit its lowest average since June last year.
"While demand is high, construction and small and medium-sized enterprises' credit ratings have deteriorated. The sector is experiencing major labour and supply chain shortages.
"Similarly, the tourism industry is still experiencing challenges with closed borders and uncertainty around international travel. While retail spending recovered post-lockdown, supply chain issues remain, causing stock delay and price pressure," says McLaughlin.
"Arrears levels are expected to increase in the first part of this year, in line with prior seasonal trends as consumer cash flows tighten following the holiday season."
McLaughlin says the credit dynamics have changed. A business credit report will give a good insight into the risk involved in partnering with customers and suppliers. It's as simple as the higher their credit score, the lower the risk of them not making a payment on time.
Companies with high credit scores are 15 times more likely to pay their bills on time than those with low credit scores.
"Using this information, business owners can protect their cash flow by only extending credit to businesses which are likely to pay on time, or dealing with reliable suppliers," McLaughlin says.
• Centrix is a sponsor of the Dynamic Business report