Non-payment can be a cause of business failure
According to an article appearing in the Italian newspaper
“La Stampa”, Non-payment can be a cause of business failure
SME’s are the most vulnerable to failure due to non-payment.
In Europe, at least one-quarter of all bankruptcies is due
to delays in payment, and these defaults cause the loss
annually of tens of billions of euro.
According to an estimate by the European commission, in 2000
one-fifth of business failures within the Union, were casued
by delays in payment of invoices with a loss of almost half
a million jobs. Many SME’s could export more product or
emerge significantly on the global market if their debtors
were punctual in the payment of invoices.
The companies most at risk are those which are most
labour-intensive, where delays in payment have an effect
principally on the vitality of the company and of its
capacity to develop and invest, with a negative impact on
jobs and salary payments of the workers. If this is the
situation in Europe, Italy gets the ‘wooden spoon’ and beats
any record. On average local bodies and public authorities
pay with arrears of 12 months.
So, what happens when payment delays occur? How should a
business react when faced with defaults?
What causes purchasers not to pay or to delay in making
payment?
The non-payment of suppliers is the consequence of a problem
which can depend on many different factors, but which are
very common amongst companies:
- Reduced consumption due to the market crisis
- Non-sale of a large quantity of goods
- The use of more than one supplier on the part of the big
companies.
According to Unioncamere (Union of Italian Chambers of
Commerce) the greater the number of suppliers which a
company deals with, the greater the length of time taken to
pay.
The opposite occurs where a business deals with a small
number of suppliers, the payment timescale is much shorter.
Unfortunately for the SME’s, it is unlikely that the big
companies will change their practices, given that a large
supplier-base guarantees more effective bargaining power.
What are the risks and how to defend your business from
payment delays.
Often companies, in order to maintain and increase
sales, grant credit to their clients - but this is not
always the most appropriate strategy to adopt. In fact, if
it is true that a greater length of time to pay will attract
new clients, it cannot be ignored that this will have major
impact on the company itself, especially with regard to an
increased costs. The company, in order to defend itself from
payment delays, should know how to manage credit in an
efficient and vigilant manner. A good dose of prudence and
pinch of distrust is no bad thing. Requests for guarantees
should always be considered among the instruments for credit
management.
The risks
The granting of credit generates a risk with 2 variables:
1. risk of insolvency
2. risk of delayed payment
In their turn, these risks generate costs linked to:
- credit management and debt recovery
- instalment payments
How to react, and what tactics to adopt
Solutions:
Company solutions: each company has its own methods for debt
collection. The latest techniques include:
- the use of automised systems for credit management. These
systems make it possible to elimate so far as possible paper
files and elaborate everything through the use of PCs. The
management of work is optimised through bill books and
reminders, data-exchange between operators from different
departments and/or legal department, reminder cards,
statistics and the possibility of attaching any type of
document. Everything is automised by control procedures at
the expiry dates, management of collections, evaluation of
risk and exposure of a client, telephone reminders, judicial
and extrajudicial collections, lawyer management, generation
of reports and statistics.
The more traditional solutions include:
- telephone contact with the debtor for the recovery of the outstanding account
- reminders by sending of messages (by fax, e-mail and post)
- the reminder letter: this is the method by which the
debtor is declared in default and, in many cases, he will
pay up immediately when required or, at least, will be open
to negotiating an amicable settlement
- the division of the credit (instalment payment)
- psychological deterrents
- the agreement. Agreeing a payment plan/mediation with the
debtor
legal action. Should the debtor not respond to reminder
letters, thereby demonstrating his unwillingness to pay or,
at least, arrive at an agreement (mediation) the company can
initiate
legal action against the debtor.
Italian Law: envisages instruments to manage and guarantee
the payment of debt. Legislative Decree no. 231/2002
provides for penalty interest, which accrues on unpaid sums.
According to the Decree, in fact, debtors who do not respect
payment terms agreed in commercial transactions, will be
obliged to pay the interest accruing from the day following
the agreed payment date or, where this is not stipulated, 30
days after the receipt of the invoice. Interest payment is
triggered automatically and without the necessity for the
creditor to commit his intention to recover the debt to
writing, and will be calculated on the basis of the
percentage fxed by the Central European Bank. The creditor
therefore has the right to the payment of the default
interest and the reimbursement of debt recovery costs for
sums not paid, excepting in cases where the debtor is able
to demonstrate that the payment delay was caused by factor
not attributable to him.
Prevention: Is prevention better than cure?. When credit is
granted to businesses, it is important to evaluate a number
of crucially important aspects (the risks and relative
costs) if the creditor does not want to run the risk of
losing a large sum of money:
1. carry out checks regarding the degree of commercial
reliability and solvency of the customer in order to
evaluate the probability of default occurring;
2. every agreement with the other party should be made in
writing, with suitable documentation in order to protect
their interests;
3. furnish a suitable and safe payment instrument which
guarantees the collection of the sum agreed.
4. Credit management which is personalised for each client.
Additionally, it may be useful to search for information on
the debtor company consulting the following documents:
- Company balance
- Bank references
- Commercial references
Remember however….
Information, even if it is reliable, can never constitute an
absolute guarantee for the creditor, but serves as a guide
as to how far to expose a company to risk as regards a given
client.
Credit Management: There are some credit management
instruments which, if used well, can become precious allies
to avoid liquidity crises.
Transferred Credit: The company can guarantee a partial
recovery of the debt through the stipulation of a
transferred credit contract (arts. 1260 & 1267 of the
Italian Civil Code). With this contract, the business cedes
his credit to a third party (usually a debt recovery
company), which assumes the risk of the non-payment on the
part of the debtor.
The most used formula is that known as “factoring”. The
party acquiring the credit and the risk of insolvency does
not do this for free, but on payment. A sum is paid to the
business (on average around 20-30%) less than the value of
the nominal credit purchased. With the factoring the company
incurs a loss, in that it has a lower return, but has
immediate liquidity without have to wait a longer period to
obtain full payment.
Remember that -
There also exists the formula ‘Pro solvendo or rather when
the assigee answers for any default of the debtor. In this
case, the contract for the creditor is less onerous, even if
the assignor company will pay legal interest and judicial
costs for obtaining execution of the credit.
Factoring: this is a contract which envisages the
assignation of a company’s commercial credit to a factoring
company which will manage such credits up until they are
collected, guaranteeing the company sometimes even the
positive outcome of a certain part of the operation.
Additionally, factoring companies undertake to provide given
services which, usually are realised in the financing of the
business through advance payment of credits. It may be
additionally envisaged that the Factor advances to the
company a part of the credit, prior to collection. On
average, the percentage advanced is around 80%, in some
cases reaching 100% of the credit.
Beware of the difference
Factoring and loans supplied by the bank both in the form of
payment of credits which have already matured, but have not
been collected, and the payment of credits which have not
reached payment date.
Resorting to a factoring contract is limited only to the
assignation of pecuniary credits by a business in favour of
a company which is able to offer particular guarantees from
the patrimonial and professional point of view.
The discount: is the contract with which the bank advances
to the client the sum of a credit, which is not yet expired,
by way of assignation, subject to payment, of the said
credit. Two elements require to be considered with
particular attention: payment of interest and the “subject
to payment” clause. So far as the interest is concerned, it
should be said that the percentage varies according to how
reliable the bank considers the debtor company to be.
The “subject to payment” clause means that in case of the
debtor’s insolvency, the company which has effected the
discount operation must pay to the bank the sum required. An
operation which must be used by the company with
considerable attention, verifying the reliability of the
debtor company. In fact, if the latter does not pay, the
company will be forced, after having paid interest, to repay
the sum advanced by the bank.
Credit manager: For every company or commercial activity a
useful way of confronting the payments problem is that of
having a credit manager at its elbow. This is a professional
who can follow the whole process, from the constitution of
the credit right through to its payment and who is able to
act in advance (recent credits have a higher possibility of
being settled in the extra-judicial phase) and of utilising
all the instruments of guarantee envisaged by the law. Even
if it is a figure more readily employed by medium to large
companies, even SME’s could benefit from the support of an
expert.
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Managing payment delays in commercial
transactions