The Late Payment Problem for Small and Medium-Sized Enterprises (SME’s).

Abstract | This report will look into an on-going

concern which more and more small businesses are

increasingly facing in light of the global economy;

according to a survey carried out by B2B Chartered

Accountants (2011), they state that the UK’s B2B

culture of late payment is getting steadily worse with

amounts owing to Small and Medium-Sized

Enterprises (SME’s) hitting record levels of around

£33.6B.

Wednesday, 14 March 2012

Student No: 310659Word Count 1,331

St. Andrews Business School | M0841 Credit Management

Contents

Executive Summary 2

Literature Review: Analysis and Evaluation 2

Conclusions/Recommendations 5

References 8

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St. Andrews Business School | M0841 Credit Management

Executive Summary

This report will look into an on-going concern which more and more small businesses are

increasingly facing in light of the global economy; according to a survey carried out by B2B

Chartered Accountants (2011), they state that the UK’s B2B culture of late payment is getting

steadily worse with amounts owing to Small and Medium-Sized Enterprises (SME’s) hitting

record levels of around £33.6B.

Literature Review

Analysis and evaluation

Late payments have reached levels in the region of £33.6 billion being owed to SME’s by

their late paying customers. The average amount owed to each firm is around £39,000 and

around half of all UK SME’s on average are waiting 28 days longer than their payment terms

as addressed on their invoices, (B2B Chartered Accountants, 2011).

Trade debtors are a key element in the working capital cycle (WCC) (Paul and Boden, 2011).

Wilson (2008), states that lack of working capital management and late payment are a

common cause of small business failure. Paul and Boden, (2008) further state that whilst

businesses may have sound business reasons for granting trade credit, the time lag between a

sale being made and payment makes way for the possibility of default or delinquency risks

resulting in bad debts.

Trade Credit accounts for 80% of business transactions, which make trade credit a prominent

part of the British trading environment, however, with SME’s being owed around $26 billion

(Manager, 2009), trade receivables is seen to be the biggest yet the riskiest asset to hold,

(Paul and Wilson, 2006; Peel et al, 2000; Pike et al, 1998).

There are, however, motivations as to why businesses (not limited to SME’s) will still choose

to grant credit when, intuitively, suppliers will want to be paid up front. Offering trade credit

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may offer business advantages which may compensate for the risks involved in granting trade

credit. These will stem from macro-environmental factors, characteristics and norms. For

example, it may be customary to offer credit. (Paul and Boden, 2011).

Such trade credit decisions, such as how much credit to assign, will be influenced by the

industry sector in which a firm is operating within. Those operating in highly competitive

markets may need to offer extended credit terms to boost their market share. Business-2-

business (B2B) companies offering credit terms can be an essential tool for attaining new

customers (CIMA, 2010).

Seasonal businesses may demand extended credit terms because of the irregular occurring

cash flows and to achieve equibrilium with their cash conversion cycle. (Paul, 2004; Wilson

and Summers, 2002; Emery, 1987)

Summers and Wilson, (1999, 1997) state that extending trade credit may also be demanded

by firms with longer production cycles and those with substantial inventories or materials,

such as firms operating in the manufacturing industry sector. Moreover, prevailing economic

conditions as well as firms whom cannot obtain credit from institutional lenders with reasons

such as their size, (in terms of capitalization) reputation or the nature of their assets and/or

products may find taking advantage of trade credit offered by their suppliers being the answer

to seeking a cheap source of short-term finance, (Atonasonova and Wilson, 2009)

Robertson, (2007) states that when a business is determining a credit policy, which sets out

the period of credit they will give to their customers, the competitive environment needs

consideration in terms of what competitors’ credit terms are being offered.

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Paul and Boden, (2011, pp735) state that where the provision of trade credit becomes a

customary practice within the business environment then businesses, such as suppliers, may

find they have little choice but to offer credit as a way of responding to demand among their

competitors, (Paul and Boden, 2011). Extending trade credit may initially look good on their

profit and loss accounts but can be a disastrous move for their cash flows later on, (CIMA,

2012).

Conclusion/Recommendations

CIMA, (2010,pp.5) state that cash flow is not only a primary indicator measuring the health

of an enterprise but is also the lifeblood of any business. It is also the most single pressing

issue which faces SME’s. In an economic environment where liquidity becomes a scarce

resource, a critical success factor for such businesses is an efficient cash flow management

system.

Cash Flow Management

Cash flow management is the practice of balancing incoming cash from trade debtors with

the outgoing cash resulting from the daily and long term financial commitments and/or

financing costs, such as employee wages, interest on debentures, paying suppliers and fixed

overheads. Careful monitoring of a business’s cash flows will enable management to be able

to forecast cash flow surpluses and deficits at any given point and to take corrective actions

where necessary early on. (CIMA, 2010).

Any cash that goes out of the business (outgoing cash) to service debts and operating costs

before incoming cash is collected from receivables could mean that businesses will

experience cash flow shortages – also known as a cash flow gap (CIMA, 2010).

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Jones, (2011) says that one of the key lessons that businesses have taken away with them

during the economic downturn is the importance of a healthy cash flow.

Setting out the agreed payment terms prior to any transaction taking place

The BIS, (2012) state that the most important step for a business to take is to formally agree

payment terms with the customer before any transactions take place – such practices should

ensure that SME’s can have a better chance of securing positive cash flows needed to invest

and expand their enterprise in the future. The B2B Chartered Accountant (2011) state that

businesses should agree payment terms in advance and to work towards a prompt payment

culture between supplier and customer.

The CIMA, (2010), pp.14) explain that being upfront regarding payment terms with a

customer is professional practice and should not be seen as ‘anti-selling’. Create an

application form for the client to sign, agreeing to comply with the payment terms and any

conditions of sale. Order confirmations and invoices should prominently show payment terms

as well as the date at which payment is expected boldly showing on such documentation. The

CIMA, (2010, pp.5) say that one in three companies did not confirm their payment terms in

writing with their customers. The FPB, (2012) say that payment terms need to be clearly

communicated on all pre-sale communications. They also point out that simply putting these

on the first invoice is usually too late in the event of a dispute.

They also say that informing customers of the Late Payment Directive, which gives

businesses the right to charge interest in covering the costs of debt collection on overdue

accounts, can be an effective way to encourage prompt payment but care must be taken not to

alienate the customer when enforcing this (FSB, 2012).

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The Importance of Credit References and Trading Data

In a study carried out by Dunn and Bradstreet, (2008), revealed that 90% of businesses grant

credit without a reference. Granting credit to businesses whom have not been reference check

ed run the risk of trading with ‘can’t pay, won’t pay’ customers.

The SME, (2011) say that by obtaining quality business and credit data is essential, especially

when operating in an uncertain economy. The best protection for businesses from writing

down bad debts is by continuous monitoring and robust checks for any changes in a

customer’s credit rating to enable businesses to make educated and informed decisions on

credit policy, which is expanded upon below:

Setting out a formal Credit Policy

Wells, (2004, p.4) says that firms benefit from a formal credit policy which can be used as a

guide for management for the day-to-day management of buyer accounts and to aid

consistent credit decisions, (Christie and Bracuti, 1981). Wilson et al, (2009) sees such

policies as part of the organisations long-term corporate strategy.

The role of the credit manager (in such scenarios) is to manage credit risk whilst at the same

time scrutinize how their credit policies in force will affect and will be affected by internal

finances as well as the prevailing market conditions (Business Credit/Diana, 2006).

Robertson, (2007) state that the key is to minimize bad debts. There requires a balance to be

met between the risk of granting credit to a customer and choosing not to trade with that

customer.

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References

Atanasova, C. and Wilson, N. (2004) Disequilibrium in the UK corporate loan market. Jour-

nal of Banking and Finance, 20 (3), p.595-614.

B2B Chartered Accountants (2012) Small businesses 'hit by record levels of payment'. [on-

line] Available at: http://www.g2bgroup.biz [Accessed: 20 March 2012].

Boden, R. and Paul, S. (2011) Sizes Matters: the late payment problem. Journal of Small

Business and Enterprise Development, 18 (4), p.732 - 747.

Chartered Institute of Management Accountants (2010) Impriving cash flow using credit

management. [online] Available at:

http://www.cimaglobal.com/Thought-leadership/Tesearch-topics/Budgeting-and-planning/

improving-cash-flow-using-credit-management-/ [Accessed: 20 Markh 2012].

Department for Business, Innovations and Skills (2012) Minister leads call to change late

payment culture. [online] Available at: http://nds.cou.gov.uk [Accessed: 8 March 2012].

Diana, T. (2006) Credit Department measure up against upper management. Busiess Credit,

[online] Available at: http://www.galegroup.com [Accessed: 20 March 2012].

Dun and Bradstreet report (2008) Dun and Bradstreet Report. [online] Available at:

http://dnb.com.au/Header/News/Business_payments_blow_out_amidst_tougher_conditions/

indexl_4258.aspx [Accessed: 20 January 2009].

Emery, G. (1984) A pure financial explaination for trade credit. Journal of finance and quan-

tative analysis, 19 (3), p.271-85.

Federation of Small Businesses (2010) Late Payment Squeezing money out of SME's. [online]

Available at: http://www.fsb.org.uk [Accessed: 20 March 2012].

FPB.org (2012) Debt guidance | managing debt | business help uk | business information re-

sources | small business information. [online] Available at:

http://www.fpb.org/page/659/Managing.debt.htm [Accessed: 20 Mar 2012].

FSB (2012) How to Create a Credit Polcy. [online] Available at: www.fpb.opg [Accessed: 8

March 2012].

InspireMe (2011) Laye payments causing problems foe SME's. [online] Available at:

http://www.inspireme.co.uk [Accessed: 20 March 2012].

Manager (2009) Late payments to SME's leap 40% to £256Bn. [press release].

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Paul, P. (2004) Strategic Trade Credit: An Empirical Analysis. PhD. Leeds University Busi-

ness School.

Paul, S. and Wilson, N. (2006) The determinants of trade credit demand: survey evidence and

emperical analysis. Journal of Accounting and Business Management, 17 p.96-116.

Peel, M. et al. (2000) Late payment and credit management in the small form sector: emperi-

cal evidence. International Small Business Journal, 18 (2), p.17-37.

Pike, R. and Cheng, N. (1998) Managing Trade Credit for Competitive Advantage: A Study

of Marge UK Companies. London: CMIA Publishing.

TheSME (2011) 65% of Credit Professionals want Government to protect SME's from late

payments. [online] Available at: http://www.thesme.co.uk [Accessed: 08 March 2012].

Wilson, N. and Summers, B. (2002) Trade credit terms offered by small forms survey evi-

dence and emperical analysis. Journal of Business and Accounting, 29 p.317-51.

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