Protect your small business cash flow by getting debtors to pay up

Small-to-medium enterprises (SMEs) don’t need a lesson in the importance of cashflow. Squeeze supply, and company working capital dries up. Turn it on, and businesses can pay taxes and wages, suppliers and overheads.

The problem is that the larger end of town has for some time now forgotten that it is not just their own cash flow that matters, but everybody’s. All businesses need buoyant receivables – all the way down the supply chain.

Credit reporting agency Illion’s Q1 statistics for 2018 show big business (500-plus employees) has recorded its 18th straight quarter of being the latest payer. While smaller companies have in the past years been assiduously improving their payment terms, the big players have barely moved theirs. Large retailers, for example, pay on average 15.5 days late. 

For a business turning over A$5 million per annum, each day of non-payment takes A$68,000 out of its cash flow. A business being paid 15.5 days late is missing A$205,000 in usable cash. 

What can small businesses and accountants do? 

Carrots and sticks

Strict payment terms may be in your contract, but big businesses unilaterally extend them. An SME can retaliate by withdrawing ongoing supply and even take legal action, but is this realistic? 

Be prepared to lose customers, says Colin Porter, CEO and founder of CreditorWatch. In his opinion, it’s better not to rock the big payers’ boat; they will simply find alternative suppliers. You need to build the business knowing that some large organisations pay in 90 or 120 days, he says.

“It’s more about planning – that is, knowing what the payment terms will be and working around that,” Porter says. 

Some big businesses have incentives if you pay early or on time, or impose fines and late fees if you pay late. Could SMEs do the same? 

Scottish Pacific’s head of debtor finance Wayne Smith doubts it. Discounts can have a bigger negative impact on gross margin than many appreciate, he says. 

“If we look at a business regularly selling A$100,000 of product to a customer each month and offering 5 per cent to get paid 30 days early, the annual cost to the bottom line would still be A$60,000 a year,” he says. 

Porter concurs: “It reduces margins and tells the customer that they can get a reduced rate – and most of the time they pay you on the same terms anyway.” 

Get in line

The problem for many is that it’s not simply a case of getting in line and waiting your turn for payment. A cheese factory that needs a reliable milk supply will always pay its milk supplier faster than its accountant, no matter who is first in line. As Porter says, many will stall paying their accountant because they deal with him or her just once a year. 

Gavan Ord, CPA Australia’s business policy adviser and manager of business and investment policy, offers a number of basic rules of thumb both accounting practices and small businesses should be using to effect faster payment times. The first is: always credit-check the customer. 

“Based on the credit check, set credit limits for each customer. Ensure that limits are recorded and that your staff are informed of the limits,” Ord says. These limits will need to be regularly reviewed. 

Second, make sure your payment terms are clear, Ord says. Document your payment terms on every invoice, regardless of how long you have been dealing with a client, and make contact with customers before the due date for payment – especially those with a poor payment history. 

Hassling late payers has its benefits, too. “If companies don’t chase, they will be paid slower,” says Porter. 

“It’s always best to run a smooth process and diarise communications. It will help keep receivables in control.” 

Ord says if payment is not forthcoming following late-payment notices, send letters of demand. If the payment is still outstanding, consider using a debt collection agency or a lawyer. 

“You do not want to create a reputation as being soft on late payers, as it may lead to further late payments,” he says. 

Debt collection agencies are probably the last resort. Porter says placing a business on CreditorWatch as a serial late payer will be more detrimental to the firm’s reputation than sending out a debt collection letter. 

Using a debt collector boils down to whether the offender is a “won’t payer” or a “can’t payer”. If they can but won’t, and the proof of delivery of service and goods is strong, then using this type of service makes sense, says Smith. 

Make sure the discount the collections company is allowed to offer the debtor has been made clear to them, he warns. “Engaging a good lawyer on a sensible hourly rate may be a cheaper option than a percentage-based success fee, depending upon the size of the debt you are looking to recover.” 

Providing working capital

If cash flow is vital and late payers cannot be trained, cajoled or threatened, there are other ways a business can maintain working capital. Having a debtor insurance policy in place to guard against defaults is one possibility. If time management is the issue, a company can enter into a debtor finance arrangement. 

Debtor finance companies offer invoice financing that allows businesses to collect the majority of the value of an outstanding invoice upfront. The small business receives most of the funds immediately, and the finance company collects the payment from the client on their own, before issuing the rest of the payment. 

How much will they finance? Smith at Scottish Pacific says it can offer credit equivalent to about 85 per cent of a company’s sales ledger. Fees and interest will vary based on the size and nature of the facility – rates tend to compare favourably with bank unsecured overdraft rates at between 11-14 per cent per annum.

 

“It’s always best to run a smooth process and diarise communications. It will help keep receivables in control.” 

 

Supply chain finance is another option. Payments are made from an investor-created credit fund, to which repayments can be made at a later time. This allows the smaller suppliers to be paid, while the larger customers can defer their own payments to maximise their working capital. 

Timelio offers this solution by embedding its own technology within the paying company. When the payer approves an invoice from any individual supplier, Timelio appropriates the invoice and (with the help of its investors) pays the small business supplier immediately. It collects the debt from the paying company at a later date. 

Clearly, there’s some work to do to streamline payments and cash flow for Australian businesses. For now, it seems the best SMEs can do is go with the flow, and work around the obstacle of late payers. 

The politics of late payment

The Payment Times and Practices Inquiry launched by the Australian Small Business and Family Enterprise Ombudsman Kate Carnell last year put the spotlight on Australia’s late payment culture. 

In response, the federal government committed to faster payment terms and greater transparency.

In the private sphere, last year a number of big businesses signed on to the Business Council of Australia (BCA) Australian Supplier Payment Code. Has it all made a difference? 

Trade information from Illion shows that business is moving in the right direction. Late payment times are at their lowest on record in Q1 2018 – businesses were paying on average 11.7 days late, a 23.5 per cent drop from Q1 2017 (15.3 days late).

However, Carnell says vastly improved payment times by SMEs are skewing the results, and the big players (companies with over 200 staff) remain the least improved. The biggest firms are still paying on average 17 days late, even if that’s a 12.6 per cent improvement on Q1 2017. 

Nor have enough big companies signed up to the BCA code, Carnell says. “The BCA members could make a stunning difference and make it quickly by just improving payment times.” 

Carnell adds that voluntary codes of payment have rarely worked and there’s every chance the government will bring in legislation. 

“If the extra red tape is necessary because they’re paying little businesses too slowly, then it’s their own fault,” Carnell says. 

“The more they pay late, the more detrimental it is to the economy. We’ve got to keep the pressure on.”