Despite signs of the world economy picking up, companies of any size can see their cash flow impacted by a significant number of late payers. Often, the easiest action a company can take is to delay payments. Once a culture of late payment has been established, it can become a significant issue, especially for smaller and medium-sized enterprises (SMEs) where payment delays can even cause them to run out of cash. Various governments have implemented a set of rules to help SMEs get paid promptly.
The European Union (EU)-wide Late Payment Directive, implemented in early 2013, addresses some of the issues that smaller companies have experienced with late payment. The Directive requires public authorities to pay suppliers within 30 days, and business-to-business (B2B) commercial companies are required to pay in 60 days, unless other terms are expressly yielded that are not “grossly unfair”. The acceptance and verification delays are capped at 30 days. Businesses are automatically entitled to claim interest on late payment of 8%, from the amount of €40 (about £30), the minimum cost of recovery. Higher interest rates may also apply if they are included in the original contract.
This rule is designed to facilitate commerce between different countries in Europe, as it standardises behaviour, and basically requires that differing ‘Southern’ or ‘Northern’ European payment behaviours be scrapped. The EU expects the rule to drive up to €40bn in attainable cash flow improvements.
In Asia-Pacific, a similar measure has yet to be implemented. However certain multinational corporations (MNCs) have chosen to use the ‘threat’ of charging interest for bad payers; an approach that appears to be working.
Penalties for late payment are not always possible. Certain industries are constrained by the prevailing competition, and must accept late payments without charging additional fee. In other cases, a company’s enterprise resource planning (ERP) might restrict application of the fee, because it is simply not able to deduct the extra fee from invoice or, alternatively, it would require too much manual work, often generating costs greater than the charge. Yet often where there’s a will, there’s a way.
More often than not, simply sending a statement with a stated interest fee will help speed the collections process. In countries where this practice is adopted, businesses fear the extra late payment charge and pay more quickly. These are some of the ‘lessons learned’ by big businesses in difficult times. Having seen the challenge of late payments and increased debt, many larger corporations have learned how to use their supply chain or the cramped interest rates to finance their activities. Here are seven straightforward solutions that SMEs can adopt to nurture a positive cash flow:
1. Information is power – know your customers inside out:
Most large companies have credit rating systems in place to assess the credit worthiness of a client. In addition, during the lifecycle of a client, they add information on payment behaviour to the knowledge base, allowing them to better assess the payment pattern of individual clients. The larger players have learned how to anticipate default risk and maximize profits. Even where an SME doesn’t have a comprehensive credit rating system in place, there are simple questions that customers can be asked to determine their liquidity:
- How do you usually pay your suppliers?
- On which payment terms?
- Does the accounting team always pay the suppliers on time or do they sometimes delay payments?
- Do you take discounts for early payments?
- While it might seem a little far-fetched there’s even value in cross checking, via Google Maps or other tools, to confirm a small customer’s address.
When you’re a small business, any risk will have a bigger impact. While a large company can rely on banks and investors to get financed, a small business survives on timely payments and agility in a competitive environment.
2. Set the right expectation from the beginning:
While big companies can better afford to make mistakes, SMEs can’t. Contracts should be simple, with clearly stated obligations (such as the correct costs) and consequences (such as interest rates and compensations), if terms are not met. Standard contracts with profitable conditions should be calculated. If long payment terms are requested by the client, the cost should be adjusted appropriately. Next to the usual contractual terms, the invoicing schedule (or date) and expected payment terms should be reflected in the terms and conditions.
3. The sooner you invoice, the sooner you get paid:
This is a surprisingly simple rule, yet many companies don’t follow it. Corporations are often confronted with an over-elaborated order management system where mistakes can occur. SMEs can have greater ability to act swiftly, dealing with clients personally. Make sure the client fills out a form with all the correct details when signing the contract. Confirm the right person to receive and pay for the invoice. Then make it easy to get paid – give the fastest recurring electronic payments method as first payment option, consider requesting advance payments from your clients. Invoice promptly and correctly the first time.
4. Establish a timely payment culture:
One of the big mistakes most companies make is in expecting payments to be timely and then being surprised when this is not the case. Bigger corporations achieve results because they ensure that the collections department is proactively tracking receivables, and approaching the clients in a timely fashion. Customers should be contacted prior to due dates, to confirm receipt of the invoice and that they have no reasons for dispute. A customer service call increases customer satisfaction, prevents disputes, and reduces default risk. Safeguarding promises-to-pay is key to a consistent collections process. On the other side, if a payment cannot be secured, the risk can be eliminated while still meagre. A sooner rather than later move towards advanced payments and reduced order/service value will also reduce the risk.
Both the carrot and the stick are useful in managing the payments process. It’s perfectly reasonable to expect your customers to follow through with made agreements, even if it means taking them to court to get them to do so. On the positive side, bigger companies strengthen relationships with clients by rewarding the best payers with discounts. This is how long relationships based on a positive payment culture are built.
5. Measure – measure – measure:
It’s critical to assess and understand the profitability of your client. Measure the time it takes clients to pay (days sales outstanding (DSO)). Know why payments get delayed, individually and in the aggregate. Reason codes for delayed payment help companies perform a root cause analysis to reduce any collections issues (for example. financial issues, payment term not known and incorrect bill-to address). Measure and analyse small issues to learn from them and build successes.
6. Early cash is gold:
In times when interest rates are low, but where a small company doesn’t always have access, cash that comes in sooner can fund the company’s activity. Close relationships with customers facilitates early payment.
- Ask if you can get paid in advance if you deliver sooner.
- Is it possible to ask for any advance payment? Staying cash positive means financing your business.
- If e-invoicing is preferred or electronic payment methods are encouraged.
- If there are any delays to your estimated payment date, ask if supply chain financing options are available.
Stay on top of your cash and the reward will come.
7. Keep up-to-date with changes in the market:
The big companies have teams of experts scrutinising all fields and aggregating best practices, value added tax (VAT) or tax exceptions, new laws to the company’s advantage or anything else that might get the company into a better competitive advantage.
SMEs often find themselves short-handed, and therefore at a disadvantage, in this battle. Look for allies, learn from the others and keep informed on the latest developments on the market. There are new proposals in different countries (such as the UK) which require large and listed companies to publish detailed information about their payment practices. Another example is the UK’s recently-introduced Small Business, Enterprise and Employment Bill which makes it easier for SMEs to access finance and improve payments from their customers. This is how to play a winning game.
China's bad debt markets are such a hot commodity that distressed assets are being sold on Alibaba’s Taobao ecommerce platform alongside household products. But the IMF warns the situation is unsustainable.
The implementation date of Europe's revised Markets in Financial Instruments Directive, aka MiFID II, is fast approaching. Yet evidence suggests that awareness about the impact of Brexit on MiFID II is, at best, only patchy and there are some alarming misconceptions.
Despite all the automation and improvements that digital banking has the potential to achieve, customers and their needs still form the very core of the banking sector.
Banks might feel justified in victim blaming when fraud occurs, but it does little for customer confidence.