Indicators of a possible default

This is assist in timely detecting a possible default with one of your customers, it is used in Impairment of investments and loans.

Descriptions of indicators of default are classified in three groups:

  • the usual financial ratios derived from financial statements,
  • market criteria, such as market conditions, the customer’s positioning and adaptability, and
  • management criteria, such as management’s experience and its behavior towards stakeholders and the society in general.

Such indicators need to be rated by management for customers according to an usual categorical scale of the type: poor, fair, good, very good and excellent (poor default risk being the worst rating).

In reviewing a chosen set of indicators the changes in the indicator and its trend (favorable or unfavorable change) over time is paramount, not only its current status. Using the trend can facilitate a forward looking approach.

Examples of financial criteria used in assessing default risks are:

Financial criteria



Operating sources of cash, operating uses of cash

Quick ratio

(Current assets -/- Inventories) / (Current liabilities -/- short term portion of long term financing)

Required financing period

Days Trade receivables outstanding +/+ Days inventory held -/- Days Trade payables outstanding

Times interest earned ratio

EBIT / Interest payments

Examples of market criteria used in assessing default risks are: Indicators of a possible default Indicators of a possible default

Market criteria


Dependence on portfolio of customers and suppliers

Concentration of customers and suppliers


Dependence on distribution channel and cunsumer choices

Production flexibility

Capacity of production progress to face market changes

Technology and innovation

Technological sophistication

Examples of management criteria used in assessing default risks are: Indicators of a possible default Indicators of a possible default

Management criteria


Timely and reliable reporting

Existence of regular and reliable information

Performing behavior with respect to investments and loans granted

Historical loan credit records

Experience and past performance

Historical information on managers’ previous successes and failures (or lack thereof)

Commitment and skills of the management team

Stability and appropriateness of management skills and choices for the specific businesses

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