17/06/11

By Martin Williams, Head of External Affairs, Graydon UK, the commercial credit referencing agency

Late payments remain a persistent problem for small and medium sized businesses in the UK. With the potential to cause untold damage to their finances, both the current and previous governments have taken steps to address this issue. However, a warning issued last month by the Cabinet Minister Francis Maude to public sector contractors who fail to pay smaller suppliers within a reasonable time frame indicates that little headway has been made in tackling slow paying corporates.

According to business lobby group the Forum of Private Business, large companies that serve the public sector are abusing the Government’s pledge to pay four fifths of their suppliers within five days, on the condition that smaller suppliers down the food chain are paid within less than thirty days. Recent research published in May by Bacs, the payments body, supports this, with a third of SMEs reporting that big businesses have not been paying their invoices promptly, with the average wait for payment now eight days longer than in June 2009, rising to 39 days beyond the agreed payment terms.

While late payment can create serious cash flow problems, and in the worst case scenario, business failure, there are steps that SMEs can take to protect themselves.

Check the viability of your customers’ businesses
First and foremost it is essential that businesses carry out credit checks on their customers. It may seem obvious but there is little point in celebrating a new customer win if that customer later becomes unable or unwilling to pay his bills.

To protect against the dangers posed by such customers, businesses need to take a root and branch approach to running credit checks and not just apply them to new customers. Assuming that customers will always pay their bills on time because they always have done so in the past is an easy trap to fall into. 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 customers from becoming a problem.

Don’t rely on just a few large customers
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 is an important consideration for businesses when looking at their cash flow.

Build a close relationship with customers
It is well worth businesses taking time to build close ties with their customers. Not only does this improve their ability to retain custom but it also has the added advantage of paving the way for firms to contact their customers personally if late or non payment does become an issue.

Address late payments in your contracts with customers
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 customer should enter into insolvency.

As it takes an average of 56 days for an invoice to be settled, 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.

Think about your own credit score

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 high credit score and the credit referencing industry has recently been urging business owners to be more transparent about their financials. As many small business owners have found to their cost, despite running a profitable business and having never defaulted on their payments, SMEs can nonetheless be labelled as a poor credit risk by a credit reference agency if there is simply not enough information available for credit referencing agencies to assess them upon.

By way of example, an independent retailer may have a profitable business but without detailed financial information it is likely to find itself judged against the current high rate of failure within the retail sector.

The experience of the business owners and their own personal credit ratings will also be taken into account by the credit referencing 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 as well as the late filing of accounts as this 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 recent warning issued by the government to its larger contractors underlines the fact that late payment is now a part of the UK’s culture. This means that even as the economy returns 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.