Any business adviser would be able to tell you numerous stories of seemingly successful business going bust or running into serious financial trouble. The order book can be healthy and the forecast for profitability good, but in the short-term the company runs out of cash, finds it can't pay the bills and that's when the real trouble starts.
In most respects the challenges of running a major bank and a small business are very different, but the common causes of financial problems are often the same:
- A major customer delays a large payment or completely defaults, resulting in a potentially fatal bad debt
- Poor debtor control
- Allowing credit without checking for creditworthiness
- Poor or no financial control
- Being under-capitalised in the first place, increasing the risk of over-trading
- Accepting large sales orders without first forecasting the effects on working capital, again increasing the risk of over-trading
- Poor security policies and procedures
The above list is not exhaustive but there are two clear themes emerging that should be given careful attention: the need for financial planning and financial control.
Planning ahead
A major customer - or for that matter a significant number of smaller ones - delaying payment or defaulting is a real risk in a tough trading climate, particularly when bank funding is tight. That may feel out of your control but there are a number of steps you can take to manage the risk and the impact on your business if it does happen.
You should avoid, if you can, being overly exposed to one or two really big customers and, if you are, you need to watch them carefully for signs that they are in trouble. That may sound like paranoia, but business collapses are rarely sudden, and it's your money that is at stake. Reliance on one key customer is quite common, so you're not alone, but in the longer-term you should develop a strategy to create a more balanced customer portfolio.
Have a column on the forecast at the side of the budget for the actual
cash in and out as of the last day of the month and compare the two. Do
this as soon as you can after the month-end
Creating a simple cash budget will allow you to forecast the effect on your bank balance if and when customers slow down payments. You should forecast for a percentage of your debtors to default. For example, you might allow for 5% of debtors as a "bad and doubtful" debt contingency, but study your customers and their past records of payment because you may need to make the contingency higher if you have a higher risk customer portfolio.
Having a forecast will also allow you to predict the effects on your cash balance of taking on that large exciting sales order, which you will have to fund until the customer pays.
Taking control
Don't bury your head in the sand; check your bank balance regularly. By this I mean several times a week, not just when your statement arrives at the end of the month. Update your cash forecast when you have new information, or at least once a week.
Have a column on the forecast at the side of the budget for the actual cash in and out as of the last day of the month and compare the two. Do this as soon as you can after the month-end and adjust the forecast for the next few months based on your current performance and your view of the immediate future. Most importantly, take corrective action where necessary.
Bank funding is very tight, but banks and other funding bodies are still open for business. If your forecast is telling you that your bank balance is at risk of dipping into the red or below the agreed overdraft limit, talk to your bank relationship manager as soon as possible. Bank lending is based on their assessment of risk so a business that shows it has a robust planning and financial control process is more likely to get support. You should also seek advice from your accountant and Business Link adviser.
Yet even the most careful company that can boast effective cashflow systems and credit control will sometimes find that it has to deal with a late payer, and that can cause your business real problems.
Under the late payment legislation you have the right to charge interest and debt recovery costs and your customers cannot contract out of it. Before charging interest, you should issue a letter stating that the payment is late and interest will be charged if it is not paid within a stated period.
Of course, enforcing this can harm your relationship with your customers so you should use your discretion before you exercise these rights. Look at each debt on a case-by-case basis by considering your relationship with the customer. It's a good idea to get the opinion of the staff who have to deal with them regularly as they are likely to have the best insight into the reason for the late payment and the impact of invoking your statutory rights. However, as a general rule, a customer who pays late without prior agreement is not one to be valued.
If you still do not receive payment you may want to use the services of a debt collection agency although this can be costly, with commission rates typically 8-10% of the debt. If you go down this route, check first that the agency you use is a member of the Credit Services Association.
Finally, as a last resort you may want to consider court action. Before commencing proceedings, though, consider whether making a claim is cost-effective. It might be cheaper to write off small sums. If court action still seems the best solution, make sure you've resolved any disputes over the goods or services you've provided. If you don't do this, the debt will be difficult to recover.
Peter Mulhall is an adviser at Business Link. For more information on financial planning and control, visit www.businesslink.gov.uk/debt or call 0845 600 9006
