Like many of you in our industry, I often read through a great deal of economic data and indicators to get an idea of where the country is headed, and how the economy affects our credit and collection decisions.
According to the American Bankruptcy Institute, all types of bankruptcies filed by businesses and consumers increased 18% overall to 445,186 in 2023. Although that was a substantial year-over-year increase, total bankruptcy filings remained below the pre-pandemic total of 757,816 recorded in 2019.
Breaking down the business data, overall commercial bankruptcy filings increased 19% to 25,627 in 2023, up from 21,479 in 2022. Chapter 11 reorganization filings increased 72% to 6,569, up from 3,819 in 2022.
According to Edward Altman, a bankruptcy expert at New York University, the increase in commercial bankruptcies has to do with the number of Zombie companies that went bankrupt.
Do you know what a Zombie company is?
Personally, I had heard the term from time to time but really didn’t have a good definition in mind. In short, Zombie companies are entities that earn just enough money to continue operating and pay only the interest on their debt obligations. Such companies, given that they just scrape by to meet overhead, have virtually no excess capital to invest that would spur any real growth.
In addition, according to an article in the Washington Post “companies that fail to book sufficient profits to cover their annual debt costs for three straight years are considered Zombies. Typically, the industries with the most Zombie companies are those with lower investment and lower employment growth.”
Altman states that the number of Zombie companies has grown from 1.5% in the 1990s to nearly 10% today among publicly traded companies in the world’s 20 largest economies. As Zombie companies operate on a shoestring budget, one little tick upward in the interest rate can force a Zombie company into bankruptcy. Since there were 25,627 commercial bankruptcies in 2023, one might assert that approximately 2,600 are related to Zombie companies.
Are You Doing Business with a Zombie Company?
How much research do you do on your clients or customers before extending them credit or choosing to work with them? If your customer is not a publicly traded company and you require their financial statements to support relatively high credit requests, the debt coverage ratio will help you determine if the firm generates sufficient net operating income to service its debt obligations.
Let’s look at the following simple example:
Formula => Net Operating Income / Debt Service Cost => $200,000 / $40,000 = 5.0
We can see that a company with a 5.0 debt ratio can easily cover its debt. Generally speaking, a debt ratio of less than 2.0 would be a red flag and should cause you to reconsider your sales, credit, and payment terms to the customer.
I hope the above has helped to shed light on what Zombie companies are and the 2023 corporate bankruptcy statistics in this country of which they are a significant part.
Nancy Seiverd, President
CMI Credit Mediators, Inc.
All Rights Reserved
Image by freepik.com
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