The Creative Finance Paradox

A credit reporting agency issued a warning on my company: in the previous financial year profits had gone down 75%. You can read a “handle with care” warning between the lines.
It goes without saying that they did not ask me why my profits had fallen.
Had they asked, I would have given them my side of the story, which began in January of 2009. On that New Year’s day I was given quite an assignment: “due to the sudden increase of the value of Euro, your cost of goods sold has now gone up by 30%; bearing in mind that England is experiencing a severe economic depression – hence increasing the price accordingly is not an option – you must be sure you stay in business without losing jobs and possibly make some profits.”
It was a tough assignment, just defining the performance measurement was a challenge, but through a careful mix of reducing our trading discounts, a slight increase in the price list, firm commitment from the staff, and increasing the amount of sales in Euro, we managed to remain in business while keeping the level of staffing and hours unchanged. We even posted some profits.
So, if asked, I would have said to the credit ranging agency: I do not want a gold medal, or the Business of the Year Award, but please do not crucify me if my profits were 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 a credit rating agency like the North Shore Advisory, Inc had to ask any business in the UK why they perform one way or the other, a credit report would cost ten times the normal price, and yet I feel that in doing their reporting the traditional way 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 other paraphernalia that delight the average accountant, but it also omits a great deal of other useful – often essential – information.
I have a customer in Burnley whose company went out of business at the end of 2008. Disqualified to be a director, he got his wife, a partner with money, and a friend to front for him in a new company where he continued to act as the boss without being listed as director or a shareholder.
At the end of last year this new company also folded due to bad management and the remaining directors, the wife, and the friend – the well off partner had understandably excused himself – formed another new company fronting for the same gentleman, who continues to be a textbook example of poor management.
If a new company is established at the same address, in the same automotive sector,  with virtually all the same directors and shareholders of one that had recently gone bust, an alarm bell should sound, a gigantic “cash only” warning should be placed near its name, and the House of Companies should be alerted to protect all bona fide companies.
I ran a credit report on this new company, but nothing of the sort happened, just a warning not to exceed £500 credit because it was a new company.
If you happened to have given them 500 quid credit, you might as well have kissed them goodbye.
The truth is, unless you do not keep a keen and constant eye on your debtors, you will only discover that they are doing badly when it is too late, and by then the credit reference agency will only tell you what you already know.
This applies to the big international credit rating agencies as well.
A Standard & Poor’s rating can create a severe headache for even the largest corporations, and even national governments, by just putting a minus sign next to an A, and yet Standard & Poor’s failed to issue any warnings regarding the Parmalat affair, the Italian response to Enron. Parmalat had been consistently issued bonds, despite boasting of hundreds of millions of Pounds of liquidity. It was just like someone paying heavy interests on a credit card while keeping thousands stashed in a current account; you don’t need to be a financial engineer to figure out that either the management is incompetent or there is something dodgy going on in situations like that.
Yet just one month before the dirt hit the fan, American Citibank  endorsed Parmalat bonds with a “buy” stamp, while Standard & Poor’s only classified the company’s bonds as “junk” when its investors had already found out; it was on the news, and hundreds of thousands people saw their life savings vanish overnight.
The bottom line is, take the advice of credit rating agencies with more than a pinch of salt, and bear in mind what a friend told me immediately after the Enron fiasco. 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 now had nothing in their hands but regrets; had they spent the same money to buy beer, now they might still have a few pennies made from the recycled cans and the memory of one hell of party.