Graydon UK provide credit rating information used within our business, the following article provides some useful insights for businesses interested in improving cash flow.
Despite the Government’s efforts to highlight the pain late payment can inflict on small firms, cash flow problems have continued to stifle the SME sector as many customers continue to withhold payment for as long as possible to protect their own cash reserves.
At the same time, a rising tally of corporate and personal insolvencies is accentuating the financial losses incurred by SMEs as their invoices are left unpaid by companies hitting the wall.
Cash flow and credit control have become major issues for business owners through the recession, second only to fears over a lack of sales and turnover, and ranking ahead of concerns over the availability of funding.
Recent research carried out by Graydon UK in conjunction with the Forum of Private Business, saw a fifth of small businesses cite cash flow and credit control issues as their key business concern, with a further 8 per cent most in fear of late paying customers and bad debts. This is in comparison with 13 per cent who were most concerned about access to finance.
The research also revealed that the cash flow position of SMEs became so weak during 2009 that almost half of those questioned (47 per cent) sought short term funding in order to cover their cash flow last year, not only through bank finance but also through loans from their friends and family and their own personal credit cards.
Even the public sector is guilty of withholding payments. Despite a pledge made in October 2008 by Lord Mandelson, Secretary of State for Business, further research carried out during November 2009 by Graydon UK amongst SMEs supplying the public sector, found that almost two thirds (63 per cent) are facing a wait of more than the standard trade invoice time frame of 30 days. Just 1 per cent are receiving payment within the pledged ten day period.
While Lord Mandelson’s pledge applies only to central government and its regional agencies this research illustrates neatly the extent to which late payments are now considered the norm in the UK. With even the public sector failing to fulfil the Government’s aim to support SMEs this serves to highlight the need for SMEs to protect their cash flow.
In this economic climate, it is easy to see why protecting cash flow is vitally important to a business’s survival. Many SME organisations are simply not big enough to employ credit professionals who know all the tricks to get money coming in on time from tardy customers. Instead, many turn to factoring companies to help them in this respect. However, for the large majority of SMEs that don’t go the factoring route, clear advice is on hand.
First and foremost it is essential that businesses carry out credit checks on their customers. There is little point in celebrating a new client win if that customer later becomes unable or unwilling to pay their bills.
To protect against the dangers posed by such customers, businesses need to take a root and branch approach to running credit checks. Assuming that customers will always pay their bills on time because they always have in the past is an easy trap to fall in to. Running regular credit checks, however, will mean that businesses will be alert to any changes in their customers’ circumstances that could lead to non-payment in the future.
Once the initial credit checks have been carried out there are a number of steps businesses can take to prevent late paying and non-paying customer from becoming a problem.
A good starting point for businesses concerned about bad debts is to look at their existing client base. Questions that businesses need to ask themselves include whether they are too reliant on a limited number of customers. If the answer is yes then this may heighten the risk that one non payment could lead to cash flow issues. It is also worth remembering that larger companies tend to be slower at settling their invoices than their smaller counterparts, which may have an impact on cash flow.
A business that builds up close ties with their customers can not only improve their ability to retain their custom but will also be in a position to keep a closer eye on their business dealings. This has the added advantage of paving the way for firms to contact their customers personally if payment does become an issue.
Small firms can also protect themselves by setting out in their contracts clear terms for credit and payment so that there is no room for misunderstandings. In addition, those that supply tangible products rather than services could consider introducing a “Retention of Title” clause into their contracts. This allows the business to maintain full ownership of their products until payment has been received, allowing them to legally reclaim all of their stock if their client should enter into insolvency.
It takes an average of 56 days for an invoice to be settled so it may also be worth businesses offering incentives to their customers to encourage them to pay their bills promptly. While the cost of this will need to be carefully considered, the eventual cost savings that this should yield can then be passed back to customers.
Having said that, even the most well run small firms can lose control of the cash coming in as well as going out and having a good credit score will enable a business to secure alternative sources of funding when their cash flow takes a hit.
It is worth remembering that it can take time and effort to build up a good credit score and the credit referencing industry has recently been urging business owners to be more transparent about their financials.
Still, many small business owners have found to their cost that, despite running a profitable business and having never defaulted on their payments, they can nonetheless be labelled as a poor credit risk by a credit reference agency (CRA).
This is usually the result of a lack of financial information available to accurately compile a credit score, but can also be caused by the differing data collating techniques of CRAs themselves. It is a fact that credit reference agencies often try to differentiate themselves from each other by topping up their databases with individual proprietary information using their own unique collection techniques (for instance, interviewing companies by phone or gathering information by sending questionnaires). Depending on the information on each database, credit scores can inevitably vary from one agency to the next. As such, at any one time, one leading agency might give a business a good score, while another one rates you down.
In order to combat this confusion the four leading credit reference agencies, Graydon UK, Experian, Dun & Bradstreet and Equifax have joined together for the first time to explain to businesses what it is that we are looking for.
As I’ve explained, a credit score is based on all the information the credit referencing agency is able to access and so in the absence of recent, detailed financial information the solution for the credit referencing agency will generally be to look at the general risks facing that business sector.
For example, a builder may have a profitable business but without detailed financial information it is likely to find itself judged against the high rate of failure within the construction sector.
The experience of the business owners and their own personal credit ratings will also be taken into account by the agency, as well as the age and size of the business and the number of employees. Any information on payment trends will also be considered.
It is also important that businesses avoid county court judgements and petitions for winding up, no matter what the eventual outcome. The late filing of accounts will also impact negatively on their credit scores.
While businesses may find that invoices are settled more promptly as the economic recovery picks up pace the unfortunate fact remains that late payment is now a part of the UK’s culture. This means that even once the economy has returned to health, businesses will need to continue putting safeguards in place against late paying customers, while ensuring that they are well positioned to secure an alternative source of funding if their cash flow does take a hit.
Martin Williams is the Managing Director of Graydon UK
London, 4th of March 2010
Lloyds TSB Commercial Finance is part of the Lloyds Banking Group