Taking credit reports with a pinch of salt

By LBV

30 Dec 2010

Here is a salutary tale that began when the agency that deals with a company’s credit rating decided to issue a warning against my firm.

In the last financial year my profit went down by 75 per cent and, in its report, you could read between the lines the words “handle with care”.

It goes without saying they did not ask me why my profits went down.

Had they, I would have given my side of the story which began on January 1, 2009. On that new year’s day I had quite an assignment.

Due to the sudden increase of the value of the Euro, the cost of goods sold has now gone 30 per cent up. Now, bearing in mind that England is experiencing a severe economic depression, the option of increasing the price accordingly is not an option. You just try and make sure you stay in business without losing jobs and possibly make some profits.

It was a tough assignment but, through a careful mix of reducing our trading discounts, slight increase of price list, firm commitment from the staff and an increase in the amount of sales in Europe, we managed to remain in business while keeping the level of staff and hours worked unchanged and even make some profit.

So, if asked, I would have said to the credit rating agency that I do not want a gold medal nor the Business of the Year Award, just do not crucify me if my profit was less than the previous year, it is good enough that we are still there.

But this is all very hypothetical and will never happen.

If the credit rating agency had to ask any business in this country why they perform in one way or another a credit report would cost you thousands instead than a tenner.

Yet I feel that that in doing their homework they follow a very narrow minded process.

If you look at any average credit report it can give you all the fancy indexes like the acid test , the gearing ratio and all the paraphernalia that delight the average accountant but omit to give you other useful, often essential, information.

I have a customer whose company went out of business at the end of 2008. Disqualified to be a director, he got other people to front a new company where he continued to act as the boss without being listed as either a director or a shareholder.

At the end of last year this new company folded due to bad management and the remaining directors formed another company for the same bloke that continues to be a textbook example of poor management.

Well, if a new company established at the same address, in the same sector, with virtually the same directors and shareholders of a recently gone bust firm does not set alarm bells ringing, a gigantic “cash only“ warning should be placed near its name and Companies House should be alerted to protect all bona fide business.

I had a credit report on this new company and nothing like that appeared, just the caution of not exceeding £500 credit because it was a new company.

If you happened to have given them 500 quid credit it would be a likely kiss-them-goodbye.

Truth is, unless you keep a keen and constant eye on your debtors you will only discover that they are doing bad when it is too late and by then the credit reference agency will only tell you what you know already.

And this applies to the big international credit rating agencies. The likes of Standard and Poor’s rating can create a severe headache to the largest corporations and even national government by just putting a minus sign by the organisation.

Yet Standard and Poor did not issue any warning on the occasion of the Parmalat affair, the Italian equivalent of Enron.

Parmalat had been persistently issued bonds despite its supposed £100m of liquidity in stock. It was just like someone paying heavy interest on a credit card while keeping thousands stashed in a current account. In situations like that you don’t have to be a financial engineer to figure out that the management is incompetent or there is something dodgy going on.

Yet just one month before the dirt hit the fan, American Citybank endorsed with the “buy” stamp Parmalat bonds, yet Standard and Poor classified the company bonds only when all investors already had sensed that. It was on the news, and hundreds of thousands people saw their life savings vanish overnight.

Bottom line, take with more than a pinch of salt the advice of credit rating agencies and bear in mind what a friend told me immediately after the Enron fiasco.

I guess it is called the “Creative Finance Paradox” and can be summed up as follows: those who had invested ten grand in Enron stock one year earlier had nothing in their hands but regrets.

Had they spent the same money to buy beer they could have a few quid made from the recycled cans and the memory of a hell of party.

Renato Cappucci

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