Credit risk assessment: seven early warning signals that precede default

Companies rarely fail without warning. They fail after a sequence of observable changes that were each individually explainable. Credit risk assessment is largely the discipline of noticing that sequence early enough to reprice, reduce or secure the exposure.

1. Payment behaviour slipping

The earliest reliable signal is not in the accounts — it is in the ledger. A customer moving from 32 to 46 average days, or from paying on receipt to paying only after a reminder, is managing cash. Slow payment is the cheapest early warning available and most companies already own the data.

2. Late or abbreviated filings

Accounts filed at the deadline after years of early filing, a switch to abbreviated disclosure, or an auditor resignation all signal that publishing the numbers has become uncomfortable.

3. Cash generation diverging from profit

Profit is an opinion, cash is a fact. When operating profit rises while operating cash flow falls — usually via ballooning receivables, work in progress or inventory — the business is funding growth with someone else's money, often yours.

4. New charges and security

A newly registered floating charge, invoice discounting facility or asset-based lending arrangement tells you that a lender has been given priority over the assets. Unsecured trade creditors move further back in the queue at exactly the moment the queue starts to matter.

5. Ownership and director churn

A change of ultimate beneficial owner, the departure of a long-serving finance director, or a rapid rotation of directors changes both the credit profile and the people you are relying on. Ownership change can also alter sanctions and compliance exposure overnight.

6. Concentration in the counterparty's own book

Your customer's credit risk is inherited from their customers. A supplier dependent on one large contract or one sector is a single-point-of-failure exposure, however healthy the current balance sheet looks.

7. Sector and country stress

Energy costs, interest rates, currency controls and sector-wide insolvency rates move whole cohorts at once. A counterparty that looks unremarkable individually can be part of a group that is deteriorating together.

Turning signals into decisions

A signal is only useful if it reaches someone with authority to act. Define in advance what each alert triggers — a limit review, a terms change, a request for security, a stop — and route it automatically. The difference between a monitored portfolio and an unmonitored one is rarely the quality of the data; it is whether the alert produced a decision.

— RisQo Research Team, Infocredit Group