The dos and don’ts of combating bad debt.
Businesses that enter administration have a slim chance of salvation, according to industry bodies and hard data.
Indeed, few small-to-medium businesses (SMBs) are able to navigate their way through the restructuring process in order to become solvent, says Kate Carnell, Australian Small Business and Family Enterprise Ombudsman (ASBFEO).
“We know there is a very low success rate in restructuring Australian businesses under external administration and the impact of the insolvency process is often devastating for the small business owner,” Carnell said, during the recent launch of an inquiry into the insolvency system. The investigation is focused on whether current insolvency practices achieve the best possible outcome for businesses in financial trouble.
The latest ASBFEO data says over 8000 businesses entered external administration in 2018/19.
Meanwhile, small-to-medium size corporate insolvencies dominate external administrators’ reports, according to the latest annual overview from ASIC. Of note, 84 per cent had assets of $100,000 or less; 78 per cent had fewer than 20 employees; and 39 per cent had liabilities of $250,000 or less.
And what’s a key reason for so many Aussie firms entering insolvency in the first place? Cashflow issues. Almost half (49 per cent) of business failures are due to poor cashflow, according to the ASIC insolvency report.
The prime factor causing cashflow issues? Bad debt, incurred from late and failed payments from suppliers.
Barbara Cestaro, client manager of Credit Solutions at insurance broking firm Aon, says a company’s most important asset can be their account receivables. And it’s hard to argue this point, given money that’s owed and not paid, is money that’s not being rightfully utilised by a business.
“With inadequate cashflow being the main reason for companies going insolvent, it is key SMBs protect themselves from the ripple effect of a debtor not being able to pay a supplier,” says Cestaro.
“It is not uncommon for a supplier to not get paid and then have issues in paying their own suppliers.”
But while managing cashflow can be a burden for some, it can become an advantage for companies that have protected their futures effectively.
Credit success, over debit demise
Poorly-handled cashflow and its central role in the demise of many SMBs entering administration and ultimately liquidation, highlights the need for protection of a company’s key asset – account receivables.
Trade credit insurance is an effective safeguard measure, which has helped companies stave off threats to the success of their cashflow. Should an SMB experience a bad debt, trade credit policies are designed to swiftly respond.
Cestaro says a trade credit insurance policy is a key instrument that can revisit and implement credit management procedures to improve a company’s cashflow. The outsourcing of debt collection activities alone, saves time and money for companies that are owed funds.
“Sometimes the cost of the policy repays itself with just the outsourcing of the collection activity as collections costs are taken care of from the insurer,” says Cestaro.
“If a company is already investing a lot of money in collecting their debts, it is very important to consider these costs when thinking of taking up trade credit insurance as these will be absorbed into the premium.”
And less time wasted on chasing bad debts, is more time gained servicing the business in more valuable ways.
“Insurers employ credit analysts to review and monitor your clients – they are experts in their sectors and not only use the data available on a specific debtor to make a decision, but also rely on the aggregate data available to the insurer. This includes factors including the likelihood of a debtor going insolvent based on region, sector, age of the company and payment behaviours.”
With insolvencies on the rise, Cestaro says banks are increasingly requesting their clients have a trade credit policy when assessing their new facility or discussing the renewal of an existing one.
Meanwhile, SMBs can use their policy to make expansion into new markets or sectors easier, by relying on the insurer’s expertise in the areas of credit assessment and collections.
“Especially when trading with export markets, a potential lack of knowledge of the export countries could be a barrier to grow the business,” says Cestaro.
“Can you imagine trying to collect a debt in a foreign country when you don’t have knowledge of how the legal system works there?”
But while a trade credit policy will help SMBs avoid cashflow inadequacies and insolvency, the process only works if the policy is properly managed.
Notifying the insurer of any non-payment must be made within a specific timeframe; if this doesn’t happen there is a potential for a claim to be denied.
“We [Aon] see this happen often as suppliers tend to be understanding of their client’s requests to have more time to pay, especially if they are a longstanding client,” says Cestaro.
“In some cases, this is just a way for the client to get more time before going insolvent. This type of policy requires the active involvement which is why partnering with the right broker is vital.
All aspects of a company’s business should be discussed to ensure the policy meets an SMB’s needs – different businesses have different approaches to receivables. It’s critical that policy requirements are clear from the start so that any internal process can be amended accordingly if needed.
And not being insured may dampen the ambitions of SMB owners from expanding – by missing out on new business opportunities due to being too conservative, in comparison with their trade credit insured competitors.
“It’s sensible for suppliers to be cautious with new clients,” adds Cestaro.
“But a trade credit policy can remove that uncertainty, once the credit limit has been approved by the insured company, the supplier can trade on terms straight away.
“Companies that are insured tend to make the most out of their policy, including offering trade terms, extending their payment terms, approaching new clients. With the back-up of the policy, an SMB has a better chance to compete.”
Find out how Aon’s Debt Protect policy streamlines the trade credit insurance process for SMBs.