With the recent collapse of Carillion in the news, it has drawn attention to the potential risks when credit is extended to any business partner. Carillion was dubbed ‘too big to fail’ by some1, but fail it did – leaving an ecosystem of business partners with unpaid bills.
Extending credit to customers is not without risks, but it’s largely unavoidable for many businesses. With Carillion still in the news, and Brexit not far off, now is a good time for businesses to reflect on credit risks and whether more can be done to defend against credit disasters.
Managing payment terms – how long is too long?
With the average payment term for UK businesses being set at 23 days2 currently, this tends to extend upwards in line with customer size. Many businesses have to cope with credit demands of 90 days or more. In the case of Carillion, they were making small suppliers wait 120 days to be paid – perhaps an indication of a business with cash flow problems?
Mike Cherry, national chair of the Federation of Small Businesses, spoke to CCR Magazine about his dealings with Carillion before the collapse:
“These unpaid bills may go back several months. I wrote to Carillion back in July last year (2017), to express concern, after hearing from our members that the company was making small suppliers wait 120 days to be paid.” Mike went on to say “Sadly, these kinds of poor payment practices are all too common among some big corporates.”
Credit has evolved from simply allowing enough time to process an invoice, to competitive offering to entice customers to speed up or increase their spending. Many supply chains simply couldn’t function without credit. Some big corporates thrive off this low (or zero) cost credit, using it to generate money and forcing suppliers into protracted terms as part of their supplier contract.
With the advent of invoicing and payment automation, through electronic invoicing and purchase-to-pay (P2P) systems, the traditional requirement for 30-day payment terms is rendered obsolete. Perhaps more businesses should be looking and incentivising their customers to shorten payment timeframes and bring the cash in sooner?
Brexit – managing credit risks outside the EU
As British industry prepares for Brexit, proactive businesses are looking outside of the EU for new trade opportunities. Whilst Liam Fox MP may be keen on UK businesses brokering trade deals with countries in South America, Africa and the Middle East, the reality is that these present far greater credit risks to manage.
One of the benefits of trading within the EU was reduced credit risk, statistically speaking. Now businesses must cautiously navigate the risks of extending credit to new customers further afield with less credit history to take into account.
As UK businesses forge new partnerships and grow their customer base outside the EU, careful management of credit risks is needed to balance sales exuberance in the face of new markets.
Carillion: banks to the rescue
When credit risks go wrong, there can be benefits to a more localised customer base. With the collapse of Carillion, major UK lenders such as Barclays, Co-Op, and Lloyds have all agreed to various degrees of change to repayment terms for affected parties. Simply adjusting loans to interest only repayments for a defined term, or allowing for payment holidays, can make the difference between payment and default.
Whilst Carillion is clearly a special case, it’s heartening to see the level of national support to support businesses in a time of crisis. This is the exception however, not the rule. History is full of examples where businesses did not receive such support in times of crisis. As we move into unchartered trading waters, managing credit risks will become more and more important to defend against risks.
Tips to manage credit risk
Few businesses will operate without taking the points below into account, but as businesses re-evaluate credit risks and prepare for growth in new territories, it’s worth reflecting on how these are taken into account.
- Thoroughly check new customers’ credit records
- Use a ‘master sales agreement’ for all new customers – individual terms can be discussed as modifications over time, but this forms a solid foundation to build upon
- Ensure credit terms and limits are set out clearly, from an early stage, and discussed to ensure no room for misinterpretation
- Closely monitor payment performance and implement a process to handle escalation and closure of late payments
- Consider credit insurance
- Consider insurance against non-payments
- Consider factoring
Insuring against credit risk
Credit insurers play an important role in reducing credit risks and protecting against late payments. Big credit insurers such as Atradius, Euler Hermes and AIG help businesses ensure cash flow isn’t adversely affected by late payments.
Some businesses take a step beyond simply insuring against late payments and engage an invoice factoring company, such as Peak Cashflow, so they can raise funding from unpaid invoices – improving cash flow.
What more can be done to manage credit risk
Aside from standard business practices outlined above, businesses should consider the benefits from better visibility and control of the invoicing and payment process. With an e-invoicing solution, such as Netsend, businesses gain real-time visibility of the invoicing process, enabling them to:
- See who has received their invoice
- See who has read their invoice
- See who has indicated their intent to pay
- See who has paid
- See who is late to pay
Insight is valuable to identify bad debtors and to take action before things become a problem, but automation takes things a step further. E-invoicing solutions can provide the following functions to assist in this regard:
- Automated communications to higher risk accounts
- Escalation pathways, including automation of statements and dunning letters
- Self service of invoicing histories, contact details and payment method changes – reducing customer service load and associated delays
Credit risks will never disappear, but electronic invoicing gives businesses better tools to manage these risks. Is your business doing everything it can to minimise credit risks?
1 The National Audit Office (NAO) issued a report in 2013 indicating that businesses like Carillion had become “too big to fail”