As per a report in the (Economic Times, 20th January 16) at the end of September 2016, the impaired assets of banks stood at Rs. 7 lac crore, nearly 12.6% of advances and up from Rs. 6.01 lac crore [Show More]

As per a report in the (Economic Times, 20th January 16) at the end of September 2016, the impaired assets of banks stood at Rs. 7 lac crore, nearly 12.6% of advances and up from Rs. 6.01 lac crore a year earlier. With credit ratings available for a small percentage of businesses and incomplete, in today’s high-risk business space it’s important to decide on your strategy to assess the credit worthiness and potential for loss if not paid when giving credit to a company.
When assessing credit worthiness of a business, there are three areas to study: Ability to pay, Likelihood of default and Intention to pay

Ability to pay can be normally be ascertained from the balance sheet or monthly bank statement of the party.

Usually likelihood of default and ability to pay mean the same thing. However many contractors in India now follow site wise payments. This means that along with the ability to pay, we need to check the likelihood of default of payments from the end customer to the contractor. This is an extremely tough exercise and usually impossible to do as the site payments can get stuck for various reasons. This obviously becomes more tougher when government jobs are involved wherein the norms to get payment are most stringent.

Last but not the least is the intention to pay even when they have the money. This can sometimes be ascertained from the balance sheet when there is a mismatch, between the debtor’s days, creditors days and profitability. However this is best understood from past experiences and hence market reputation. A number of factors determine this:

1. Cultural norm of business: Industry trends and terms

2. Cultural norm of country: Japan pays before due days

3. Market environment: We often hear market is bad so everyones payments are delayed

4. Terms of payment (dependent on payment of another deal?, technical terms, performance guarantees etc.)

All in all, the point is that for larger orders (in the business of the case study company) above Rs. 10 lakhs and definitely above Rs. 25 lakhs, we need to cover all the above as there is a mismatch in the risks involved in terms of amount, the value profit being gained from the transaction and the overall value profitability of the business to take the hit incase of default.

Other options that may give further idea are:

1. Credit report but these are usually too technical to decipher and will only tell you about the ability to pay.

2. CIBIL score of the managing director to check whether his personal credit card, loan and other payment are being made in time. This again tells you about the ability to pay only.

The infrastructure industry is cyclical. A lot of money has been previously stuck due to wrong credit judgment, which is what caused the case study company to not allow the sale. Perhaps the cycle is turning but we would tread with caution due to amount and profitability.