Regaining financial control

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Wednesday, 08 December 2010 04:23

For the UK SME, the rapid increase in the value of late payments is beginning to cause serious problems.

In the current financial climate, organisations are exploring every possible avenue for reducing costs and improving financial control.

But for the UK SME, the rapid increase in the value of late payments is beginning to cause serious problems, with organisations owed an average of £32,000 at any time – up from £25,000 in the last six months alone.

Add in the costs associated with credit control and manual payment processes, as well as the risk of late payment penalties, and the situation is becoming critical. However the vast majority of these issues could be massively reduced if organisations moved from outdated cheque-based payment methods to Direct Debits (DD). With improved payment control, reduced credit control and an average saving of £10 per payer per year, isn’t it time for SMEs to reconsider the DD? asks Adrian Stafford-Jones, Managing Director, Albany Software.

Late Payments

Interest rates may be holding steady and the economy showing small yet steady growth, but for the majority of UK SMEs day-to-day business remains challenging. According to figures released by Bacs Payment Schemes (Bacs), in June 2010 British SMEs were owed £24.6 billion in late payments; up nearly £600 million from December 2009.

Almost half (45%) of SMEs nationwide have experienced late payments, and debtor days, the length of time beyond agreed terms that organisations are waiting for payment, have now reached 39.4. The business costs of this escalating late payment trend range from cash flow crises, forcing short-term borrowing (where possible), to massive costs incurred by finance departments chasing payment.

But this problem is not only restricted to those collecting payments; there is also a knock-on effect and cost incurred to those due to make payments. Indeed, finance teams are spending far too much time fending off demands from supplier credit control departments, as well as juggling cash flow whilst waiting for cheques to arrive and be cleared.

A vast majority of SMEs are affected by late payments, with 79% of organisations still paying bills by cheque. Yet glitches in the postal system and the manual processing of cheques are far from unusual and increase the problem further. In this highly payment-sensitive marketplace, any problems that delay payment will increasingly raise the chances of suppliers placing a stop on overdue accounts. Just how will businesses continue without access to supplier materials or services?

Late payments will, of course, become considerably worse following the VAT increase from 17.5% to 20% in January 2011, adding significantly to the value of overdue payments. So what are the options for UK SMEs?

Cheque Deadline

With cheque clearing facilities due to be phased out by 2018, there is growing demand on SMEs to look for alternative payment mechanisms. The vast majority of larger organisations have eagerly embraced Corporate Direct Debits, gaining a considerable reduction in late payments and far greater control over cash flow.

One of the key benefits of using DD is the streamlined collections process. Automated collections and the provision of electronic reports can be integrated with the core financial software to maximise efficiency and provide transparency. Indeed, with the recent announcement of the Direct Debit Indemnity Claim Automation (DDICA) system, every element of the DD payments process is now electronic and automated.

And the value to business is significant. According to Bacs, on average local authorities can save £10 per year per Direct Debit payer. So why are other organisations, most notably SMEs, not opting to take advantage of the potential savings on offer from collecting payments this way and why are 76% of SMEs still accepting payment by cheque?

Creating Incentives

The numbers clearly add up for the payee. But just how can organisations overcome resistance from their customers? DDs provide measurable benefits for every organisation involved in the payment process. The payer knows when the payment is due because it is scheduled and happens automatically. This not only reduces the administrative process associated with preparing and making payments, but also cuts the number of calls from creditors, further reducing the finance overhead.

Essentially the DD approach gives the payee organisation control and confidence. The cash is debited from the bank account at a set time, as expected, unlike cheques, which can take days to arrive and are not always immediately cashed, putting further pressure on the cash flow management process. With confidence in the DD process, organisations no longer risk the payment glitches that can significantly damage critical business relationships.

So how can SMEs encourage customers to adopt Direct Debits and address this damaging late payment problem? One lure is the fact that it is the DD originator, not the payer, who incurs the transaction fee; which represents an immediate financial benefit to the payer. The second option is to use DD as a negotiation tool, offering either extended payment terms to those that adopt DD payment or a surcharge to those that still opt to pay via cheque.

Economic Success

Either approach will gain the attention of the customer’s Finance Director and hopefully provoke a much overdue debate about the role of the Direct Debit within the SME marketplace.

There is, however, one more hurdle to overcome - the banks. Banks have traditionally been unwilling to extend the Direct Debits service to SMEs, fearing the risk associated with unlimited indemnity. Nevertheless, with late payment values and the business risk growing, there is a strong argument for banks to reconsider the merit of the DD model to the SME market.

The future success of the UK economy will undoubtedly be influenced by the performance of the country’s 8 million SMEs. Minimising the impact of late payments, driving down debtor days and allowing organisations to impose far more control over cash collection and cash flow will be key. With the increased VAT rate looming, now is the time for both Finance Directors and their bankers to look closely at the benefits Corporate DDs can deliver to the SME market.

Tags: financial control finance late payment

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