A £64bn question hangs over UK business: how to unlock this amount, which is one estimate of the cash that could be freed by speedier payment. The figure traditionally drops sharply at this time of year, as firms struggle to turn more sales into cash and tie up less in inventory. But such short cuts to cost cuts could take expensive revenge in Q1 2008.
A new survey of payment delays suggests that £64bn may be trapped in transit among UK firms – not a sum they can easily spare at a time of tightening short-term credit markets. This is the amount that would be released if average days sales outstanding (DSO) could be reduced to 45 days, according to a representative sample of over 30,000 in-financial businesses conducted, combined with official date on company turnover, by document solutions provider Formscan. It is offered as a "realistic and conservative" estimate of the cash that businesses could free up if they made clients pay up more quickly.
Late payment remains a top complaint among small and medium enterprises (SMEs) in most recent surveys, with last month's Asset Based Finance Association poll finding more than half having problems recovering payments within the specified term, and over 44% struggling with clients who ask for extended credit terms.
Small companies urged to seek more symmetry in receipts and payments
Larger businesses, as always, show up as the worst offenders, collecting payments more rapidly than they dispense them so that their average DSO is under 50, compared to almost 70 for smaller companies (below 150 employees). The Open University Business School's small enterprise research team reports that over 50% of SMEs are owed more than they owe others in trade credit, and only 17% are able to take longer paying than it takes them to be paid. The gap between accounts receivable (AR) and accounts payable (AP) becomes the trap that drains firms’ working capital, when suppliers force them to pay promptly and clients aren’t similarly forthcoming with their cash.
Formscan MD Chris Haden says the findings highlight the "obvious opportunity to combine AP and AR," exploiting the similarity in documentation for the two and the way they are processed. Compared with the indirect savings from improving stock management or HR deployment, tying AP and AR together and automatically matching invoices to purchase orders generates an immediate and measurable cash saving. "Some companies centralise the finance function to cut costs, but don’t recognise that unless they link these processes, they can multiply costs at the centre."
One reason larger companies can legitimately let AP run ahead of AR, Haden points out, is that their systems quickly deliver invoices in a form that customers can handle, and require suppliers to invoice them in a similarly processable format. Small suppliers whose payment demands need to be scanned or re-keyed are automatically condemned to a lengthening DSO. Small businesses’ legal defences against late payment are not extensive in the UK, and not always effective where formally stronger elsewhere in Europe. Getting even, by improving invoice efficiency, appears a better SME strategy than getting mad.
Easy come, easy go – year-end cash grabs return to haunt
Cutting the AR backlog doesn’t help, however, unless the increase in cash generation is sustained. European companies achieved a EUR35.5bn (£25.4bn) improvement in Q4 revenue last year by improving AR collection and reducing inventory; but much of this gain was reversed the following quarter, with net working capital more than doubling in the engineering/construction and durable goods sectors, and rising by more than 50% among utilities and distributors.
Consultancy REL, which compiled these figures, identifies a range of end-year 'budget games' through which companies make quick gains in cash generation efficiency, which are equally quickly shed. The main ones:
- Inducing customers to buy more: creating a bulge of discounted sales at the end of the year, followed by a sharp decline the following quarter as buyers work through theirn own excess stocks
- Chasing payments more intensively: putting seasonal strain on the AR department, and advancing payments so that receivables again fall sharply the following quarter
- Slowing down purchases: buying as little as possible by running down stocks: leaving the shelves empty for the start of the next year, when a rush of purchases mayb overstrain suppliers and leave customers waiting
- Slowing down outpayments: letting AP rise, causing damage to supplier relationships and causing a new year cash shock as the overdue payments have to be made
- Overproducing: spreading the overheads as thinly as possible so that recorded earnings improve – but subsequently locking up more cash in inventory, as production runs ahead of what's been ordered, even with the desperate discounting to spark sales
"Although discounting seems benign, it actually trains customers to hold out for further discounts in the future," observes REL president Stephen Payne, a seasoned spectator of the end-year games. The same is true, argues Formscan's Haden, of discounts to induce early payment: reducing AR because there's less to receive, when the real aim is less waiting to receive.
