Innovative policy solves cashflow crises

Mark Dempster, head of direct debit management services at Premium Credit, explains how small businesses can make a difference to their cash collection with a simple credit policy.

Good and regular cashflow is crucial to every business, but none more so than the small business. Remember, cash is king and small businesses need regular injections. However, by the very nature of how many small businesses grow and develop they are often challenged before they even get going. Under-capitalised from the start, constantly starved of cash and often under-funded. Many fail financially through no real fault of their own.

This coupled with the fact that in the UK it is almost taboo to talk about money, let alone ask for payment and the small business spends its entire existence working as a debt collector.

Raising an invoice for many small businesses is an act of faith, hoping that payment will be made at an appropriate time in the month before the cash is required, a process that all too often goes sadly wrong. Regular monitoring of the intention to pay that invoice is invariably outside the realms of possibility for the small business, with many holding huge amounts of unpaid debts on the balance sheet like some financial graveyard.

Another Achilles heel for the small business is the perpetual squeezing and bullying by the larger organisation, just like a cat playing with a mouse before administering the final deathblow. It is not uncommon for the larger client to dictate to the smaller supplier his own payment terms for this client relationship.

Every supplier has the right to dictate its own payment terms, whatever they may be: Pro-Forma, cash on delivery, seven or 30 days. The choice is yours. However, all too often the larger client dictates his own payment terms, which may be as long as 90 days and the small business will simply comply for fear of losing the deal.

How many times when you present your invoice and want paying quickly have you been told, “we can’t pay that, our terms are 60 days” or “this may be a pro-forma invoice, but our cheque run is at the month end”. You wouldn’t say to your high street butcher that you were planning to pay for Sunday’s leg of lamb three months later.

The task of managing cash flow and collecting outstanding debts has another detrimental effect on the business as it can damage the client/business relationship. There is no more an emotive task than collecting money. The client relationship should generate energy, with the client delighted and enthused by the supplier’s delivery. In a small business that is perpetually close to closure through poor cash flow, that energy is soon sapped by the constant nagging for payment.

In 1998 the Government introduced the Late Payment of Commercial Debts (Interest) Act to protect all businesses. Two years later, the second phase came along, allowing small businesses the right to charge late payment interest against any other business not paying on time, regardless of size. It is almost an open secret that late payment is far from constructive to any party other than the non-paying company that is using its own supplier base as an interest free overdraft facility.

Has this Act made a difference? Some would say no. The small business owner wants a flow of cash into his business, rather than an interest payment on a debt he cannot collect. A late payment can have a devastating effect on a company and is a common cause of business failure.

Surprisingly, though, only 2% of small businesses surveyed agreed they would turn to a third party funder to manage the process of collecting cash. These simple statistics are set to impact on small business in the South East during the latter half of 2006.

In this quest to determine what the defining factor is between a larger business and a small business, it is perhaps relevant at this point to compare the difference in professional attitudes towards credit management. What can the smaller business learn from the larger business? Is the size of a business an indicator that processes are correct?

Why are small to medium sized enterprises so bad at collecting cash? One reason may be the lack of internal resources. Small firms may find it cheaper to outsource their cash collection to a third party, rather than make the necessary internal investment. Volume may be another deciding issue; with so little volume going through the business that it yet again does not warrant a dedicated internal resource.

What can a small business learn from these statistics? Clearly the larger the business the more rigid the credit policy becomes. This is a practice that can be adopted by the small business. Size should not be a pre-cursor to efficiency or the lack of it. If the smaller business thinks like a larger business, it can expect to be treated like a bigger business.

A simple credit policy is easy to set in place:

· Ensure you have clear Terms and Conditions, to contract your clients to your business, seeking legal advice from your solicitor.

· Ask your clients to complete Account Application forms before starting to do business with them.

· Set credit limits for your clients and continually review them. Don’t let your clients have unlimited credit, this will ensure that if a problem does occur you limit the danger of large unpaid debts.

· Ask your clients for Purchase Orders for all transactions. This will reduce the number of disputed invoices that could lead to a late payment.

· Send out regular monthly statements.

· Use commercial credit scoring to assess your clients’ ability to pay before you start to do business with them.

· Set cash collection targets, especially in weak periods, such as the holiday months of June, July and August.

· Have a policy for collecting overdue invoices, which should include a standard letter in the first instance, a solicitor’s letter and finally legal action, depending on the size of the debt.

· Consider using a third party to collect monies, such as fee spreading of professional fees to collect all monies.

There is so much statistical evidence to suggest that the small business is far more vulnerable than the larger organisation when late payment is the issue. With a little bit of forward planning, the small business can ensure it doesn’t become one of those statistics.