Late payments are an increasingly hot topic. Many small businesses aren’t able to hire staff, improve their business or grow fast due to a cash flow gap. So, why do late payments matter? Because when a large business takes advantage of its market power to unilaterally extend or delay payments to its SME suppliers it either hinders the growth of those suppliers or pushes them towards bankruptcy.
This is reprehensible because:
1. It steals jobs and economic growth from all of us and reduces the cohesiveness of our society.
2. It unfairly targets SME owners who are major contributors to our society.
3. It lowers Federal and State tax collection.
How can I justify making these statements?
Let’s start with the facts on the contribution of SMEs to our economy and society. Did you know SMEs employ 68% of the workforce, generate 55% of Total Industry Income and 66% of Total Industry Profit?
What about stealing jobs and economic growth from all of us? We need to first begin with a little financial education. The trading activity of a business involves the sale of stock and the collection of debtors related to those sales. To trade, a business needs capital, which is just a fancy term for the money a business raises from its owners and/or its bankers. The amount of capital used to support trading is called working capital.
A business owner can use the following equation to quantify the capital tied up in Working Capital:
∑ Stock + ∑ Debtors – ∑ Creditors = Working Capital
You will note that Creditors are a deduction in this equation. This is because Creditors are a source of finance for the trading of a business. Using the working capital equation, we can see that when Debtors increase, all other things being equal, the amount of money tied up in working capital also increases. So, what causes Debtors to increase? One cause is business growth. Higher Sales are usually accompanied by higher debtors. Another is a unilateral extension of payment terms, or a deliberate delay to payment times by your customers.
How do SMEs feel about late payments?
SMEs can normally manage one, but money is not as freely available to SMEs. To the extent that it is late/extended payments causing the increase in working capital then growth suffers.
The working capital equation also helps us understand why payment terms are extended and/or delayed. If a large business can delay paying its creditors (ie: its SME suppliers) it lowers its working capital. Doing this allows it to redeploy that freed-up capital elsewhere in its business.
Why don’t SMEs do this also?
Well, for most, this is not a sustainable strategy. When they do, it’s usually an involuntary reaction caused by mismanagement (losses) or delayed payments requiring them to conserve their scarce capital. Ultimately, if an SME can’t pay its creditors then it will go bust.
It is hardly surprising then that most SME owners get hot under the collar when a large customer, by delaying payment, puts their planned growth and/or their business at risk.
So, what can an SME owner do?
1. Make sure all your customers know your payment terms.
2. Enforce those terms by calling late payers and requesting payment. When calling explain that you delivered your side of the bargain by supplying the quantity and quality of product/service requested and now you are asking the buyer to deliver on their side of the bargain by paying on time.
3. Work to diversify and expand your client base. You have more options when you are not reliant on one or two significant customers. You get to redeploy the time freed up into growing a business with customers who will pay.
4. Have a budget that helps you identify the working capital needed for growth. Allow a buffer. If you can’t produce a budget easily find someone who can.
How do you feel about late payments? Let us now by commenting below.
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