The title of a Simply Red song comes to mind when surveying the current cash situation of businesses. In some boardrooms and workplaces it may simply be a case of ‘Money’s Too Tight to Mention’ – but the fact is all businesses rely on solid cashflow to remain healthy, and it is time to put proactive cashflow management strategies in place if you want to still be around in 2010/2011 when the economy recovers.
There can be no doubt that cashflow is getting squeezed across all sectors of business. As to its severity, it’s all a matter of who you talk to.
There is concrete proof, however, that debtor days are being pushed out. The Dun & Bradstreet Business to Business Trade Payments Analysis in December last year showed the average payment period was 50.8 debtor days per client – almost 70 percent longer than the standard term. Big companies (200 to 499 employees) were the slowest payers, averaging 52.6 days to settle accounts.
“The result of these businesses being starved of cash is that this often causes a spiral effect in SME businesses,” says Trent Brown, CEO of Ezypay. “This can lead to SME businesses reaching a tipping point where they stretch out payables too far and experience an interruption to supply of services, which in turn impacts their ability to deliver to customers. It’s hard to recover from that position because of damage to reputation and disruption to supply hindering further sales.
Rod Marvin, vice president of the
Marvin is surprised at how well companies have held up until now, considering the drop in demand for products and the tightness of liquidity and bank funding. His assessment is based on the payment patterns of customers his company deals with (he is also finance director of Rayonier Asia Pacific Forest Resources).
“Payments have become more viable, with some customers varying their payment terms away from a single monthly payment to multiple payments. And there are some who have become overdue. But in the main, nearly all are still paying when due or within the next month.”
Tackling debtor days
Minimising debtor days (the time debtors take to settle their account) is central to controlling your cashflow, and there are many strategies businesses can adopt in order to achieve this.
Graeme Hill, general manager business development for Lock Finance, suggests businesses consider debtor insurance to cover for non-payment of accounts. Communication is also the key he says – sending our regular reminders, making customers aware of the payment timeframes, being proactive and, if necessary, negotiating terms – perhaps a payment scheme that includes direct debit.
With Lock Finance also a leading player when it comes to debtor finance and factoring, it’s no surprise that Hill’s best advice is to unlock the cash that’s tied up in to debtors account and outsourcing your accounts collection to another organisation, such as his company.
More on factoring and invoice discounting later in this article.
Meanwhile there are other steps to take to speed up payments. Trent Brown offers the following four useful tips:
• Invoice fast. Too many businesses complete a job and the work sits in a tray waiting to be invoiced. Every day a job is not invoiced is a day longer the cash takes to flow into your account.
• Relationships with accounts payable. In many cases when a SME is actually paid is determined by accounts payable staff. At the same time these people are often starved of recognition, so a little bit of relationship management goes a long way. Identify the account payable representative at the time of contract signing and start the relationship before an invoice hits his or her desk.
• Colour your invoices. Your invoice does not have to be on corporate stationary. Make it stand out by using a single flat colour in line with your brand (the brighter the better). This way it will be easy to locate in a pile of invoices.
• Use proactive payment channels. Use direct debit as a means to collection. This puts control in your hands and ensures payment on time, every time. Some people feel this is a big ask, but all businesses ask for discounts or progress payments, particularly large businesses, so use direct debit as a bargaining tool. Let your customer know that you can only afford discounts or progress payments if you are paid on time, and with this in mind you would be happy to accommodate the requested (if you can) so long as they pay via direct debit. With increasing staff reductions, direct debit is now seen as a preferred method for payment collection due to the reduced administration for the invoiced customer.
Advice on cashflow management
The key to maintaining cashflow is to first understand how your accounts receivable are performing. What is the average debtor age and what customers are constantly letting you down? Know this and you’re better able to tighten up your accounts receivable processes says Mark Tadecicco, national managing partner, specialised finance for BNZ.
He also recommends strict invoice management, discounts for prompt payment, and see if money can be freed up by reducing stock.
“Can slow-moving lines be reduced or put on sale? It might pay to reduce some items quite heavily to get money in quickly.”
Businesses should also look at innovative ways of funding from their banks too, says Tadecicco. “The BNZ has a range of specialized lending products – such as debtor finance, asset finance and stock finance – which provide access to more funding without pouring any more of your own equity into the business, maximize your leverage in bank lending and help keep your cashflow position strong.”
“Understand how your cashflow relates to your monthly balances, and manage your operating cycles so there is always enough cashflow to cover you.”
Work on a monthly cashflow forecast that extends out for the next 12 months he says, and keep it updated. “If say, you see a problem looming in the next three months you may need to talk to your bank or creditors. But supplying them with the right information is the key – it’s not acceptable if it’s supplied too late.
“Your business plans and forecasts need to be based on real information, because they will be tested. Lock Finance, for example, always tests the assumptions of its clients.”
Rod Marvin’s suggestions for getting through a cashflow crisis include modifying your banking facility. “Surprisingly, it is possible to renegotiate your covenants with your bank or banking syndicate. This can be achieved by moving the terms of the facility to current market pricing or amending your covenants to something more achievable.
“However, be aware that this can be expensive and may not be easy to achieve.”
Improving short-term cashflows, says Marvin, can be achieved through selling non-strategic assets, reducing operating costs and capital expenditure (or deferring), negotiating extended payment terms with suppliers, and for exporters – negotiating or deferring out of money contracts or hedges.
Trent Brown’s panacea for cashflow problems is a total new financial paradigm.
“A total reliance on debt is a prescription for hard times in any market. Of course, there is an important role for debt in regards to capital investments a SME might make. But when it comes to day-to-day operations, we’re working with businesses to have them develop this new finance paradigm, one that helps small businesses develop a positive cashflow.
“That is, with the ever increasing pressure to provide customers with payment terms in the current economic climate, we are supporting businesses in instituting effective self financing options.
“This practice promotes the regulation of spending by allowing SMEs to match expense with re-occurring income, thus avoiding the debt spiral. Whilst Ezypay currently collects approximately 98 percent of all payments directly on the day they are due, they also assist with the collection of dishonoured payments through an electronic payment follow up system.
“Through this system we fill the void faced by many small businesses when self financing, which is exposure to bad debts. As a consequence many of our customers are finding that they are securing their cashflow at a much lower cost and in a much more efficient manner.”
Debt factoring and invoice discounting
If there was a miracle pill that could take away all your cashflow blues, then there’s a good chance it’s in a box labelled debt factoring or invoice discounting. This type of credit option comes in many guises, from full service debt factoring (where the total debtors ledger is handed to a third party to manage and administer on a long-term basis) to invoice discounting aka invoice or debtor financing (with debtor collections/relationships still managed by the client).
Aside from the fact that banks are pulling away from traditional ‘working capital’ overdrafts, it’s no wonder that this form of cashflow management is proving to be popular in the recession, because it essentially unlocks the cash tied up in your debtors ledger – often the biggest asset a business has, by far. Funds are generally made available within 24 hours – up to 80 percent of the value of the invoices.
“Debt factoring or invoice discounting effectively turns sales into cash, and invoices into instant cash,” says Lock Finance’s Graeme Hill. “It’s a tool to quickly release cash, and the great thing is, as your debtors ledger grows in value, your ability to borrow against it also grows.” But he points out that funding is only provided for approved debtors – as would be expected, they must meet certain criteria. Clients must also have good accounting systems and processes in place, which Lock Finance will assess, along with conducting bi-monthly audits. This is standard practice within the industry.
Invoice discounting has been popular for years across the Tasman, Hill points out, where all the banks provide the service. He sees this eventually being the case in
Speaking of which, the BNZ’s Mark Tadecicco explains that invoice discounting is also an ideal facility for a growing business which requires funds for further expansion – especially where traditional sources of funding have dried up.
“It’s confidential, so the business retains the relationship with its customers, and crucially in the current economic environment, it can also prevent the need to secure business lending against personal assets,” he says.
“With our invoice discounting facility 80 percent of debtors is funded on day one. What we’re seeing currently is businesses using more of that facility than they were 12 months ago. This is an indication that things are tighter in the marketplace – suppliers are being stretched by as much as 10 to 15 days by debtors in order to keep more cash in the business.”
Invoice discounting is not suitable for smaller businesses with less than $1 million turnover, Tadecicco points out. “Any business that deals with a ‘sell and forget’ type product is suitable for invoice discounting – as long as there is no contractual or ongoing maintenance element to the supply of those goods.”
The BNZ offers three products tailored to the needs of different types and scale of business, says Tadecicco.
“And the third option is stock finance – aimed at businesses with turnover of $3 million or more. This is a full trade cycle, working capital solution for funding the purchase of raw materials or wholesale goods at the beginning of the trade cycle. It provides working capital funding for businesses right up to the point of manufacture and is especially beneficial for businesses having difficulty raising funding through traditional overdraft facilities.”
The crucial difference between full-service debt factoring and invoice discounting, explains Tadecicco, is that with the latter, maintenance of the sales ledger (and therefore contact with the debtor) remains with the client.
“Some businesses can be uncomfortable with the management of their debtors being given over to a factoring company.”
Dave Cooper, national manager for Scottish Pacific Business Finance, believes that one benefit of debt factoring often overlooked is that having the collection work done for you frees you up to get on with running the business. “It also puts an expert into your company to collect the debts – it’s simply outsourcing of a job that most businesses don’t do well.
“Also,” says Cooper, “the cost of factoring verses invoice discounting is not simply that invoice discounting is cheaper. The client gets nothing for the admin fee charged on an ID facility – whereas in factoring they are getting a collection service and good reporting of conversations between the factor and the customer.
“We think that invoice discounting becomes more viable at $2 million per annum turnover, and often the company is happy to pay a premium to have the facility remain confidential.”
No silver bullet
While it has become increasingly popular, invoice financing is no silver bullet for companies strapped for cash. “A business that is burning cash, will still keep burning cash,” suggests Edward McKee Wright, manager invoice finance for MARAC – who has been active in the sector for around three years. “All invoice discounting does [in these circumstances] is postpone the inevitable.” Invoice finance as with all working capital products is for customers that are achieving profits he says, or will achieve profits when they are able to achieve the additional levels of turnover that invoice finance will allow them to.
McKee Wright says the average period a client partners with them is two years, and he’s skeptical towards one-off invoice arrangements. “Unless the client makes enough profit on the one factor to fund the next project, they run the risk of rolling over to the next big invoice, and the next, and so on. Invoice finance is a product that helps customers achieve their long term business goals. If you have a working capital shortfall this month, you probably will next month, so you should look for the long term invoice finance solution.”
He believes invoice financing is especially suitable for service industries – MARAC’s customer base includes manufacturers, distribution service providers, transport companies and exporters. “But make sure you shop around – there are many different invoice finance products out there that will achieve different outcomes for your business.”
Scottish Pacific’s Dave Cooper agrees that no factoring facility anywhere will help a badly run business. “But a good business that is profitable, but being hamstrung by lack of cashflow can grow in leaps and bounds with the certainty of regular cashflow that our facilities can provide.”
Factoring began around 30 years ago in the
He says banks have become more comfortable with invoice discounting “principally because of an improvement in systems and risk monitoring”.
“As a result there has been a gradual move away from factoring to invoice discounting.”
If your business is considering factoring essentially you need to know that the factor will recover the debt faster than you can, says Tadecicco. “Factoring hands over complete control of the sales ledger to the factor – including debt collection, help with dispute resolution and full management of the sales ledger with regards debtor days.
If you are considering invoice discounting check that the provider will fund 80 percent of debtors on day one, he says. Check what restrictions may or may not apply.
“Remember that invoice discounting is cheaper than factoring because there is no collection activity with this facility.”
The final word goes to Lock Finance’s Graeme Hill.
“Factoring is perfectly suited to either fast growing companies requiring funds to assist growth, or companies with debtors as their main asset, as this product releases the cash tied up in these debtors. Traditionally it may have been regarded as expensive, but in the current environment the cost is not a lot different to other forms of finance.
“Look for a factoring company that is flexible, has been in the market a long time, has credibility, and a product that suits your specific industry.”