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Tips to avoid firms with murky finances

Accelerate SME


Often, a company's insolvency impacts dozens of its suppliers and stakeholders. But almost always, there are warning signs before that happens. Learn to spot them so you can help your own business steer clear of trouble.

Due diligence is important, especially when filtering potential suppliers, business partners or contractors, according to Vincent Sovis, executive director of Dubai-based Sovis Quantity Surveying, a company set up by his father Ivan Sovis, who has been a UAE resident since 1976. The young Sovis is also a commercial and construction law expert.

Conduct an in-depth research

Using his company's experience as an example, Sovis said part of the commercial and contractual service they provide to clients is the undertaking of an extensive pre-qualification process, which seeks to ensure that only qualified and capable contractors or suppliers are selected to participate in a tender.

"We would undertake a series of information-gathering exercises, which typically includes application forms, trade license, company details, company personnel and organizational chart, company management systems, quality management system certificate and manual, parent company guarantee (where applicable), insurance coverage documents, audited financial reports for the past three years, summary of corporate social responsibility activity for the past three years and company profile including projects delivered in the past five years, as well as respective references," Sovis enumerated.

He added that it is important to investigate whether the company has won any awards or obtained any accreditations or certifications. The number of years it has been operating in the UAE must also be taken into consideration.

"We also find that it is important to meet the key staff that will be involved in the project and find out how many years they have been in the UAE, their understanding of the local UAE construction customs and regulations and how long they have worked for the company," he said.

Track payment patterns

If a company always pays on the nail, and then fails to do so two or three times, something is happening. It could be simply that the accounts payable manager has gone on maternity leave and her replacement hasn't got the hang of things. More likely, the company is financially stressed and is trying to make its funds last by paying bills late. Build a system into your accounts that automatically tells you if customers have changed their habits.

An expansion in the amount of credit a customer is taking can also be a sign of trouble. It might mean they are growing or winning business, but if it's coupled with late payment or a request for longer terms, it may show that they're hitting financial trouble.

Some firms will try to switch more of their business to a supplier that offers longer terms, or that hasn't pursued payment actively, in order to stretch out their funds. Keep an eye on their ordering patterns too; if they order more without paying the previous invoice, or if they only pay their invoices when they need to reorder, that could be a sign of insufficient funding.

Look out for cash flow problems

Check the earnings reports of corporate customers for signs of cash flow problems. One of the first sign of struggles with cash flow can be an expansion in days' sales outstanding (DSO). A company that is unable to get paid, whether because it's been overtrading or because its own customers are in trouble, could be heading for insolvency.

Check the company's payables too, as a percentage of its costs. If a company keeps increasing its credit from suppliers and is taking longer and longer to pay, you can guess that your cash flow isn't a priority. If at the same time your experience has been that payments from that customer are past due, then there's a clear warning that either the customer is taking advantage, or that something is up.

Debt service ratios are also important. If a company's interest payments take up more than half its operating income (before interest and tax) it could have difficulty servicing its debt in the event of an economic downturn or slow markets. That's particularly the case where a company's sales depend on a small number of major contracts, for instance in the software sector or in contracting. While banks tend to look at the balance sheet, that's not so useful to suppliers, who don't have a charge over the assets and don't rank high up the list of creditors when it comes to a liquidation.

Check the credit standing

It's also worth checking the notes to the accounts for details of the company's debt. In particular, debt repayments that are imminent and not covered by cash will need to be refinanced. If there is any difficulty in refinancing - for instance if banks are unwilling to increase their exposure to the industry, as happened in the case of commercial property during the credit crunch - the company could go to the wall. Some debt may be fixed, while other debt is floating rate; again, there could be refinancing issues if interest rates move up and a cheap loan has to be refinanced more expensively.

The currency of borrowings can also be important; companies which have borrowed in a currency other than their domestic one could be exposed to currency swings. While that might not be an immediate problem, make a note of it on the customer record in case it becomes an issue.

Sometimes problems come out of the blue, but entrepreneurs who have strong business acumen and understand how to mitigate risks associated with their industry would emerge unscathed, or at least with a business that's still solvent.

© Zawya BusinessPulse QATAR 2016

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