Amid spiking interest rates, rising costs, a tight talent market, and a troubled supply chain, businesses are facing bigger financial challenges than they have in decades, a reality that is impacting the bankruptcy rate.  

According to data from Epiq Bankruptcy, the total number of U.S. commercial bankruptcy filings rose 18% in the first half of 2023, with 12,107 businesses entering bankruptcy during this time. 

Consumer data suggests that the issue will get worse before it gets better, according to Brian Holden, Chairman and CEO of AR Funding. “Seventy-five percent of the savings people accumulated during the pandemic are gone, and what’s left, people will hang on to, given what’s happening to interest rates and gas prices,” predicted Holden. “Employment rates are strong, but the average number of working hours is going down. There are a lot of economic signals right now that indicate companies will experience a lot of financial pressure.” 

Even if your business is financially sound, your operations could still be disrupted if one of your key customers or suppliers is caught up in the wave. Financial or reputational costs, lost prepayments or deposits, or lost revenue for unpaid products and services are just a few of the issues you could face. 

Here are seven ways to identify the risks and protect your business from the effects of bankruptcy in your customer base or supplier network. 

Know the law

The first step in protecting your business against a bankruptcy among your customers or suppliers is to understand your rights as a creditor. 

“Bankruptcy protects the person filing,” Holden pointed out, “But the people that end up financing it are the debtors.” 

To understand the basics of bankruptcy, including the steps to take if you need to press a claim against a debtor, this guide to bankruptcy basics from the United States Courts is a good place to start.

Do the research

When AR Funding onboards a new invoice factoring client, we conduct extensive research into that client’s customers in order to ensure that every invoice will be paid on time and in full. Any business can conduct similar research into their customers and suppliers to confirm their financial resilience. 

For example, if it is a public company, you can find details of their financial history and current financial profile online. Start with a Google search to collect as much information as you can that way, then use Yahoo Financial to seek out the company’s financial statements and analyze its credit-worthiness. If the company is private, you can obtain a business credit score for them from companies such as Dun & Bradstreet, Credit Safe, or Experian, to name a few. 

Note that a basic credit check can cost upwards of $100, so may not always be a realistic option. In this case, you can request the company’s financial statements, including balance sheets, income statements, and cash flow statements. 

You can supplement this financial information with reputational information from customer or industry reviews on sites such as G2.com, Clutch.co, Better Business Bureau, and Google reviews.

Don’t accept “no” 

Many companies don’t realize they can ask their suppliers and customers for financial information, but it’s just good business practice. Customers and suppliers perform their own due diligence on their vendors and partners, and they shouldn’t be reluctant to share their financial details with you.  

At a minimum, a company should require a bank and trade reference for new customers and suppliers, no matter how big or well established they are. If you encounter resistance, consider it a red flag. A reputable company will respect your diligence in requesting this information. 

Understand the costs

Many businesses fail to calculate the real costs of a situation where they are unable to collect payment for a service or product delivered. Holden pointed out that a $200,000 write-off could cost the business up to five times that amount in real revenue. 

“What people don’t think about is that if your gross profit is 20% and you write off $200K, you have to earn a million in sales to replace what you just lost,” he explained. “That’s why nonpayment can be so hard to recover from.” 

Understanding the real impact of nonpayment in the event that a customer defaults on payment or a supplier prevents you from delivering on a contract can help you justify the efforts required to research and continuously monitor the financial health of your key customers and suppliers. 

Pay close attention

Researching your suppliers and customers through credit bureaus, news, and reviews will help you evaluate their financial and reputational standing, but once you are doing business with them, the way they behave can also reveal potential issues.  

“You might see trends where customers go from 45- to 65- or 70-day payment terms,” said Holden. “They might delay a payment here and there. They might request a discount or a break. These are clear red flags and a signal that their cash flow is hurting. If they say they are okay but their pay history is getting longer and longer, don’t put off having a conversation with them.” 

Avoid overreliance

Don’t become too reliant on a single supplier or customer. As a general rule, if a single customer accounts for more than 10% of your revenue or your top five customers account for more than 25%, your customer base is under-diversified. Similarly, if a single supplier has the potential to significantly disrupt service or product delivery, your business is at risk. At a time when bankruptcies are becoming more common, it’s more important than ever to correct this type of overreliance. Look for opportunities to redistribute the way revenue is earned, and look for ways to build relationships with alternative suppliers in each critical business area. 

Never compromise

No matter how big or established or reputable a company is, never let your guard down or relax your standards for due diligence.  

“Look at Yellow Freight,” said Holden. ” They were the largest freight company in the U.S. and some of our customers did business with them for decades. But if you looked for the signs, you could see that they were not managing their debt effectively.”

Be ready for the wave

Based on recent economic and market indicators, the incidence of bankruptcy is likely to increase over the next 12 months. Businesses that take steps to evaluate and prepare for the disruption this could cause within their customer base and supplier network can minimize the impact and enhance their resilience. 

During periods of financial volatility, invoice factoring and reverse factoring (also known as supply chain financing) can help buyers and sellers in a supply chain improve cash flows and protect themselves from delayed payments and nonpayments. To find out whether these options could help you, talk to a factoring expert in your area.