SMEs: Focus on Credit Management
Times could be getting tougher for the UK’s small- and medium-sized enterprises as analysis of recent economic data from Atradius reveals a rise in firms suffering from cash flow problems. The number of company liquidations, insolvencies and bankruptcies increased in 2005. Company insolvencies were in excess of 12,000 in 2005, whereas insolvencies in general topped the 60,000 mark, according to government figures – an indication that the number of business failures in the UK is increasing.
Around 99 per cent of UK firms are defined as SMEs so this is particularly disappointing for the country’s smaller companies, often seen as the lifeblood of the economy. For instance, SMEs can have a direct impact on their local economy. They employ their workforce from nearby communities and use local suppliers for the products and services they need. Invariably these SMEs link into a network of other small companies, which means if one business fails, many others will feel the pain.
The reasons for small business failures are varied and, as a result, figures show that around half of all new start-ups fail within their first three years. One of the biggest factors in the failure of many businesses is poor credit management, which ultimately leads to an irreversible strangulation of cash flow.
One problem is that credit control is not often seen as a management issue, or an issue that should be addressed at board level. Credit tends to be a function that comes a poor second to sales – after all, sales mean income and income means cash flow.
A sale is only a sale, however, when the invoice has been settled and the money has been collected. A GBP1m order is worthless until the cash is in the bank and is actually a drain on the business because of the expenditure on raw materials and labour needed to produce the item or service that has been sold. If a company then has to wait 60 or even 90 days to get paid, then their costs are increasing in terms of lost interest on the income, bank charges they may have incurred and any additional interest payments on their own borrowings.
Atradius estimates that outstanding invoices can be anything up to 70 per cent of a company’s trade assets. The amount of trade debt owed to businesses across the whole of Europe at any one time is in the region on euro90m.
The only thing worse than being kept waiting for payment is not being paid at all. If a company does go bankrupt, then it is very likely they will go bust owing hundreds of thousands of pounds to a long line of creditors. And if your business is in that line-up, chances are you will have to wait a long time for a settlement and be lucky to recoup even a fraction of what you are owed.
The situation is made more precarious and complicated if the business is trading abroad. The expansion of the EU and the growth of economies in India and China means there are great business opportunities opening up for UK companies looking to export their products and services. But it also means that establishing the stability of your trading partner is much tougher as well. The legal framework of firms in regions, such as Eastern Europe, also means that if your customer is slow to pay, or has gone bankrupt, it can be painfully time consuming and incredibly difficult to get any recourse via the courts.
These all tend to be issues that land on the credit controller’s desk after the sales team have gained all the glory for winning new customers. A more strategic approach to credit management is needed and it should begin right from the start, even before the sale is made.
Credit terms must be agreed in writing before any sale is made and they should be strictly adhered to. Building up a good relationship with your client’s finance or accounts department is also crucial, so you know who you should speak to in order to chase up payment when your outstanding invoices reach their due date. The personal approach will often help short-circuit any problems and stop an overdue invoice from becoming a major cash flow problem.
It is the lack of basic information that makes credit management such a tough job. According to research carried out by Atradius, more than two-thirds of UK firms regularly receive incorrect invoices from their suppliers. The biggest mistake, according to 82 per cent of the companies surveyed, is that invoices either have the incorrect address or are sent to the wrong addressee. By comparison, the second most frequent invoicing mistake, incorrect VAT, was reported by less than one in 10 of the businesses surveyed.
The majority of companies, around two-thirds, said that the number of incorrect invoices they received each year is less than 10 per cent. Significantly, however, one in five firms said that between 10 and 25 per cent of the bills they get has an error.
Mistakes on invoices are not only annoying; they can also cause cash flow problems for the companies that issued them. According to the research, only 3 per cent of firms were willing to pay invoices that contained errors. Most companies, around two-thirds, said they rejected incorrect invoices and sent them back to the supplier, demanding a corrected one. One in 10 businesses refused to pay the invoice at all.
According to a third of firms, receiving an incorrect invoice could delay payment by anything up to a fortnight, whereas one in five companies said that the delay was more likely to be between two weeks and a month. In fact, 15 per cent of the businesses surveyed said their suppliers would have to wait an extra 30 days at least to be paid if their original invoice was wrong.
There will, of course, be times when payment is not forthcoming, either because a customer cannot or will not settle their bills. Collection agencies offer support by chasing up the debt on a supplier’s behalf, using their knowledge of the legal system and financial requirements to reach a settlement wherever possible. Collection agencies with a global reach are particularly useful when the debt is with an overseas customer, as they will normally have the local knowledge to navigate through the legal maze that may exist.
Another option is for firms to take out credit insurance to protect themselves against the impact of bad debt, usually paying out up to 95 per cent of the value of the outstanding invoice. These insurance policies can be used for customers both in the UK and overseas.
Whatever small businesses do to improve their credit management, one thing remains true: without a strong and strategic credit control system, companies will never be able to guarantee problem-free cash flow, no matter how good their sales figures are. And that could mean that they are only one bad debt away from becoming another of the UK’s growing number of business failures.