Over half of all small and medium enterprises (SMEs) experience late payments or working capital issues in their business, with 27% receiving late payments from customers. Today, it is estimated that SMEs write off around £12k per year. So what can you do to help reduce this risk? We spoke to James Sinclair at Trade Finance Global about what companies can do to help them manage their cash flow.
1. Deep dive into your supply chain – can you renegotiate terms?
Any finance director or supply chain manager should look at their end to end supply chain, that is, suppliers, end-customers, banks and operating partners in their business to try and renegotiate credit terms. As an example, you can ask if you can pay your suppliers on 60-90 day terms (after you have received the goods), and reward your customers for paying on time (perhaps with a discount if payment is earlier, or penalties for late payments. This breaks the cycle of the payment gap which can easily cripple a business.
Much accounting software also has the ability to send automated emails if payment is not received; saving time and money and ensuring the business has cash to pay employees on time, grow the business and cover operational costs.
Many banks charge interest or overdraft fees for accessing additional credit or business loans. Often this is time consuming (to apply for and to be accepted for credit), requires security (e.g. physical assets or business property) and often the business might just want credit for a fixed period of time to pay a supplier and fulfil a large order.
There are two types of financing an SME could consider for short term finance:
- Letters of Credit and Trade Finance
Any business trading goods or services overseas may want to open a Letter of Credit (LC) or trade finance facility which uses the goods as security for the transaction, rather than the business or director guarantees. Often less time consuming and passing the risk of the goods to a funder, trade finance and Letters of Credit are becoming a popular choice for SMEs.
- Invoice factoring
Invoice factoring, also known as debt factoring, is the process whereby a funder takes responsibility for handling the sales ledger. The factor is also responsible for collecting the cash your customers owe you directly without little or no involvement from your business.
In this instance, customers tend to know that there is a third party responsible for collecting the payment on your behalf.
Invoice factors typically pay around 85% of the total invoice amount, and once the money is collected from the customers, the remaining amount is paid to, less interest and fees.
Figure 1: Summary of invoice factoring, advantages and key facts. Source: TFG
3. Research, research, research
It’s always essential to do due diligence on your customers, suppliers and key accounts. In a world of increasing regulation, especially around know-your-customer, know-your-goods and anti-money laundering, researching your key partners couldn’t be more important.
Today there are several credit reference checkers and research tools to watch out for any red flags, although it might also be advisable to work with your compliance teams, or get a third party to conduct due diligence on your behalf. Here are a few simple tips to get you started:
- Check social media and following of the business, as well as their website
- Checking credit and trading history on companies house, as well as director details
- Asking for recent customers / testimonials, and use services such as Feefo / Trustpilot to check if they are legitimate
- Looking at directors / partners of the business on LinkedIn
- Look at the markets they trade in to, and the types of goods and services they offer to other customers
- Requesting a sample of the goods if you’re placing a large order
4. Hedge your currency
In today’s world of currency volatility, any business receiving payment in different currencies faces balance sheet risk, especially when they are trading on thin margins. By way of example, in the last 4 months, the pound has strengthened against the euro
The most basic strategy is to use a Forward Contract. This allows you to lock in an exchange rate for a period of up to 12 months. This means you know from the outset exactly how much an international payment is going to cost in your local currency.
Alternatively, many businesses take advantage of Currency Options which offer protection from negative shifts in the currency market while providing the flexibility to take advantage of any favourable market swings.
For any trading business, cash flow is king, in order to meet the demands of your employees, the operational cost of running the day to day business, and winning new business to expand and grow. Just a few simple tweaks to the way you charge invoices, the payment terms with various parties you do business with, and considering options to mitigate currency risk can have measurable impact on your bottom line.