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The D word
9th February 2009
Credit is drying up, Gordon Brown used the D word and SMEs
are bearing the brunt of the worse economic downturn since World War II. David
Thomson, Chief Executive Officer of Close Invoice Finance, offers some practical
tips on survival and specifically, managing cash flow.
Not a day goes by without more bad news about the global downturn. While the
Government makes ever more drastic attempts to kick start the economy, the harsh
reality for many SMEs is that they are facing one of the toughest trading years
on record.
But the slowdown is only one part of the story. This recession is unusual in
that it has been caused by a crisis which has essentially seen banks stop
lending – to each other, to businesses and to consumers. The combination of a
lack of liquidity and plummeting sales means that business managers who don’t
have a sharp focus on managing cash will see their businesses fail. In the
fourth quarter of 2008, insolvencies jumped by 51 per cent to 4,607* compulsory
liquidations and creditor’s voluntary liquidations (CVLs) in total in England
and Wales, the highest level recorded in one quarter for five years. Some
businesses fail because they are simply not viable but too many will fail
because of poor cash flow management. The phrase “cash is king” may be a cliché
but it has never been more true.
So what can you do about it? Assuming that everything possible is being done on
the sales side, the cash position can be improved in two ways: by managing down
late payment and by being smarter about accessing credit (in a low credit
world).
LATE PAYMENT – THE SCOURGE OF THE SME
When it comes to payment terms, size most definitely matters. Large businesses
have the power to extend suppliers’ payment terms for the benefit of their own
cash position. This trickles down through the economy, with terms extending at
every level. Latest figures show that it takes on average 88 days for businesses
to pay an invoice, with analysts predicting that this could rise to more than
100 days in 2009*. The direct impact is a shortage of funds to finance stock,
staff, overheads and creditors. What’s more, it means that businesses can
struggle to service any short term debt.
In an attempt to contain and stop the spiralling impact of late payment on the
SME sector, the government recently introduced a policy to speed up the payment
of invoices to smaller businesses. The code, developed with the Institute of
Credit Management, was launched by business secretary Lord Mandelson at a
‘Prompt Payment’ summit attended by companies including Asda, John Lewis
Partnership and British Gas. It sought to establish clear policy in paying bills
with the facility to raise concerns about late payers.
At present, however, the policies in place have done little to alleviate the
disruption caused by late payment. A 10-day deadline for the settling of
council’s debts for example, had negative reception from councils who brandished
the policy as an unrealistic expectation that would produce more red tape. If
the Government can’t persuade councils to comply, there seems little hope that
big business will.
1. Tackle cash flow head on and acknowledge the problem
If businesses continuously experience excuses for non-payment, they need to
tackle the problem head on. The main mistake companies make is that they act too
late. Sometimes this is down to not knowing what to do but often it’s simply the
fact that late payment and bad debt becomes the norm – days become weeks and
weeks become months. Late payment poses a serious threat to SMEs, and needs to
be addressed in an equally serious and decisive manner.
2. Terms of trade should be crystal clear
At the order stage a business should ensure terms of trade are clear and
accurately reflected on all relevant documentation, in particular invoices -
verbal agreements are significantly harder to prove. In the euphoria of landing
a new order or client, it’s all too easy to forget to negotiate payment terms.
If there is no agreed credit period, the law sets a default period of 30 days,
but being transparent from the outset is far more effective.
3. Build a strong client relationship
Building a strong relationship is crucial in these difficult times and can help
businesses better support clients and manage the risk of bad debt. Good
communication is often all that is required to solve payment issues between
debtor and creditor. As well as regular ongoing contact with the sales or
service contact, try and establish a “friend” in the finance team. All things
being equal, this should improve payment, but at the very least will ensure that
you have as much information as possible about the state of your customer’s
business, so that you can plan accordingly.
Where late payment is unavoidable, always try to agree a payment plan and never
forget to document what has been agreed.
4. Think carefully about charging interest in the early stages
Steps can be taken such as charging interest on late payments, although in our
experience this can be counter-productive. Charging interest rarely encourages
payment (unless debts are exceptionally overdue and the interest amount is
considerable) and generally has a detrimental affect on your relationship with
the client.
5. Know your tolerances and be decisive
Do not confuse having a good relationship with clients for being a pushover.
Statements should be issued at the expiry of the payment term and then at
regular intervals. If, following the introduction of a payment plan this is
subsequently ignored, there needs to be a clear process for taking legal action.
6. Legal action
The first step in taking legal action (and often the most successful) is to
issue a seven day ‘threat of action’ letter from a solicitor.
If payment is still not forthcoming, be sure to follow through threats of legal
action as failure to do so will significantly dilute the seriousness of the
situation in the eyes of the debtor. Your solicitor will suggest the best course
of action, from making a small claim to pursuing the debt through the county
court to issuing a winding up order. At this stage, we would advise exercising
your right to add interest to the debt. Under the Late Payment of Commercial
Debts (Interest) Act 1998, which applies to all contracts agreed after 7 August
2002, interest can be added to late debts at a rate of the Bank of England base
rate plus eight percent.
A SMART APPROACH TO ACCESSING CREDIT
Access to credit has become increasingly difficult over the last two years.
Banks are increasingly reluctant to lend and many companies find existing
facilities are being reduced, withdrawn or priced out.
One of the few remaining sources of funds is therefore invoice finance, from
independent companies such as Close Invoice Finance. The central premise of
invoice finance is that it allows companies to raise cash quickly and easily
against their sales ledger, affording businesses a greater degree of flexibility
and control over their cash flow
Despite the deterioration of the credit profile of many businesses the
fundamentals of factoring and invoice discounting haven’t changed - we are
interested in the integrity of debt not the company balance sheet or rate of
growth. We therefore approach businesses in a very different way to traditional
lenders who are focused on more obvious indicators of business success. Invoice
finance can represent a lifeline to companies that have seen other forms of
trade finance dry up.
There are essentially two types of invoice finance product. The first, invoice
discounting simply provides finance against a percentage of the value of
outstanding invoices. The facility is more often than not confidential and the
client business retains control over invoicing and collection.
KILLING TWO BIRDS WITH ONE STONE
However, here at Close Invoice Finance we are actively encouraging our clients,
where appropriate, to consider factoring as a means of addressing both debt
collection (tackling late payment) and providing an injection of working capital
into their business. Unlike invoice discounting, where clients ‘own’ the
invoicing and collection processes, with factoring, we manage the whole debt
collection process. Because we have a dedicated team of collection specialists
we are not only very effective at managing late payment, but our clients are
freed up to focus more effectively on running their businesses.
With IDeal™, our unique online invoice discounting product, the real time view
of client accounts affords us an even more competitive approach to risk, which
in turn releases higher levels of working capital against the invoice book.
Finally, if a “belt and braces” approach is called for, such as today’s crisis
would suggest, we recommend that clients consider our bad debt protection
product.
Although in the current market credit limits can be low, and at first sight
perhaps not what the client hoped, the expertise and disciplines that come into
force through our Bad Debt Protection facility – such as encouraging deposits,
stage payments or pro forma terms for specific debtors or contracts causing us
concern – can often prove to be life-saving in the long run, when their customer
becomes the next surprise victim of the recession.
There is no doubt that 2009 is going to be tough, but approaching late payment
head on and seeking alternative sources of credit than the traditional lenders,
will go some way towards ensuring that solid businesses survive, and are well
positioned to prosper as we go into the next cycle.
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