Four steps to identify zombie businesses with credit reports

Many businesses in Australia felt the crippling effects of the COVID-19 pandemic, and some of them were on the verge of shutting down due to unsurmountable losses. However, the Australian government offered a helping hand to these businesses – providing stimulus and various moratoriums, which allowed businesses on the brink to keep operating.

Now that the government’s pandemic support programs are ending, the same businesses that the government aided are feeling its pinch. Industry experts have predicted a grim 2022 for businesses operating in various industries.

After giving a lot of leeway to struggling businesses during the pandemic, the Australian Tax Office (ATO) has resumed the regular tax collection service. As a result, businesses face the heat, and many become zombie businesses. Working with zombie businesses can be catastrophic for Australian small-to-medium enterprises (SMEs). Here is how credit reporting can be helpful in terms of identifying the credit risks of working with zombie businesses.

What are zombie businesses?

Zombie businesses are businesses that cannot pay the principal amounts on their loans – only paying the fixed costs and the loan interests. These businesses continue to operate in the grey area between functioning and insolvent businesses.

The term ‘zombie business’ emerged in the aftermath of the collapse of the Japanese economy back in the 1980s. As the country’s economic collapse threatened to lay waste to thousands of businesses, Japanese banks intervened and allowed businesses at risk to keep operating. However, after the economy’s condition had become stable, the financial support provided by the banks came to an end, and the businesses were left in limbo.

For B2B SMEs, it can be challenging to identify zombie businesses, as nothing tends to seem wrong with them from the outside. Quite simply, zombie businesses put your own business at risk for bad debts. Thankfully, there are ways for SMEs to avoid zombie businesses, and we’ll take you through one of the most effective ways in the next section.

How SMEs can avoid the zombie apocalypse with credit reports

Using commercial credit reports is an effective way to identify businesses. Credit reporting agencies are responsible for providing these reports, which provide credit scores and detailed insights into the financial health of businesses. Understanding a business’ credit standing will help you gauge an existing client’s financial health and capacity to pay you on time.

If a business is seeking to transact with you, you can also use credit reports before approving credit applications and go through them thoroughly. 

The following credit report practices can help you steer clear of zombie businesses for good.

1. Keep a close eye on ATO tax defaults on credit reports

If the credit report mentions ATO tax defaults, it’s a cause for concern. The ATO started reporting unpaid debts to credit reporting bureaus during the pandemic as a punishment for businesses that failed to manage their tax debts. A business’s outstanding debts may be reported to credit reporting agencies by the ATO if the business:

• Has an Australian Business Number (ABN)
• Isn’t an ‘excluded entity’ by definition
• Has a tax debt of at least $100,000 and is 90+ days overdue
• Isn’t considered by the ATO to be ‘effectively’ engaging with it for the management of its tax debt
• Doesn’t have a complaint being considered by the Inspector-General of Taxation regarding its proposed tax debt information reporting by the ATO

Additionally, the ATO’s reporting mechanism isn’t automatic. Before the ATO reports a business for its tax defaults, it has to send a written notification and allow a 28-day period to manage its debt through engagement with the ATO.

The ATO will only provide tax debt information to registered credit reporting agencies. Interest charges, penalties, fringe benefit debt, superannuation debts, activity statement debts, and income tax debts are the different types of business tax debt included in the disclosure threshold.

Related blog post: Six Key Steps for SMEs to Manage Credit Risk

2. Study industry reports from credit reporting agencies

Credit reporting agencies publish periodic industry reports that contain information relevant to various industries and their businesses. Studying these reports can help you understand industries’ financial health status and the companies operating within them.

Industry reports consist of deep insights into high-risk industries and the regions within Australia with the highest default risk. These reports can be of incredible help in terms of understanding the industries and businesses you should steer clear of working with.

3. Reach out to customers who are in high-risk industries

It would be best if you also got in touch with existing customers operating in high-risk industries based on what you learn from studying industry reports. This is easier said than done, as approaching customers with whom your business has had a long and successful relationship regarding their financial status can be difficult. However, it’s something you must do if you want to avoid bad debts.

The first thing you need to enquire about is the status of the business, i.e. how things are going behind the scenes. Remember that even in the worst financial health, a business will do its best to put up a brave face; that is why honest and transparent conversations are essential. State your concerns openly to your debtors and encourage them to do the same.

If your customers are in the retail, hospitality, or construction sectors, asking questions is vital, as these industries have been hit hardest by the COVID-19 pandemic. The construction sector, especially, is in crisis as several big-name businesses have already closed their doors, and experts warn that many more will follow in their footsteps.

Related blog post: The Human Side of Accounts Receivables Automation

4. Reassess payment terms with customers on the risk of default

• Do group-based sorting of your customers: This will allow you to establish risk profiles and identify patterns. For instance, customers concentrated in a particular region that fail to make timely payments are indicative of the ongoing financial risk that the area carries. Segmenting clients is also a great exercise in understanding the spread of your customer base, i.e. customers’ contributions to your turnover. Examples of groupings include trade sectors, domestic customers, customer size, and product categories.
• Refer to your business’s ageing report: You can use AR automation software to generate an ageing report for your business. This report will tell you your business’s accounts receivable records based on the length of each outstanding invoice. The time individual customers take to make payments will become more evident through this report. Apart from assessing your customers’ financial health, an ageing report can also help you understand the problems in your industry and sales practices.
• Study each customer’s creditworthiness: Commercial credit reports can help you understand the creditworthiness of each customer, especially in assessing credit applications. You can also assess their financial statements -if available – to estimate their short – medium-term solvency. The most critical component to look at across your customers’ financial statements is the operating cash flow, i.e. the cash that their current operations generate. Also, compare their industry’s average debt-to-income ratio to their ratios.

Related blog post: How an enhanced credit application process can protect your business from bad debts

As the Australian government, banks and the ATO continue on their return to normalcy, more and more industries and businesses are likely to be hit as their financial support dwindles. Access to credit information and industry reports and keeping communication lines open between you and your clients can help you avoid falling prey to bad debts from zombie businesses.

Get a closer look at your debtor’s credit risk

Save your business from zombies and bad debts with help of Credit Insights from ezyCollect in partnership with Illion. Get free business credit scores when you get started today.

 Book a free demo of ezyCollect and discover how AR automation and integrated credit reporting can work for you.