28 October 2012

That was week ending 26th October 2012

Last week saw the end of recession with growth of 1% in GDP in the last quarter. This is of course the end of the second technical recession we have experienced; it may not be the last. If you are just about keeping your head above water it doesn't take much to push you under again. The government keeps coming up with a variety of schemes to kick start growth in the economy but they don’t seem to be generating much traction. However two events from last week made me think about why this might be.

Pay me now, tomorrow, sometime, never.

On Tuesday the government announced its new “supply chain finance” scheme, with David Cameron hailing it as a “win-win” solution for large companies and their suppliers. The principle is that a large company will notify a supplier’s bank when an invoice has been approved for payment. The bank can then offer an immediate advance of 100pc of the invoice value to the supplier at lower interest rates knowing the bill will be paid. Government estimates that this would enable leading companies to make available as much as £20bn of cheaper finance to their suppliers.
There has already been a fair bit of comment on the idea with the consensus that this scheme could work but only in a limited number of situations.  However the question that occurred to me when I first heard the announcement and which began to be voiced by others towards the end of last week was:
If a large company approves an invoice for payment why doesn't it then just pay the invoice? 
To quote Philip King, Chief Executive of the Institute of Credit Management (so he should know), “my preference would be that people just paid on time”.
The real problem for small and medium size businesses financing their debtors is the UK’s slow and late payment culture, which is now endemic throughout the UK business system. The late payment legislation has now been in force long enough to prove it is not the answer, certainly not for small businesses trying to extract payment from large customers.

Paying on time pays off

Apart from the obvious benefits to cashflow for many suppliers to large businesses would paying on time actually benefit business and the economy overall? Or is it just an ethical argument and I am being naive in thinking that paying bills on time is a realistic proposition? Well here’s a true story.
A family owned specialist retailer based their growth strategy on 3 principles, the latest products and technology at competitive prices, outstanding customer service and advice and, paying suppliers on time. This last principle was the key to enabling the other two. When goods were delivered, provided they conformed to spec, quantity and agreed price, the invoice was approved and logged for automatic payment on the agreed date. The supplier knew that provided they performed they would always receive payment on time. Consequently they did perform and gave this retailer their best prices and service and always offered them the latest products and technology first.
This is an example of how a sufficient and balanced flow of credit through the business system creates competitive advantage. The retailer expanded from one premises in one location to a nationwide chain to become a household name in its sector and highly profitable. Eventually the family sold out to a venture capitalist for a handsome sum. The new owners’ strategy was that having bought the market leader all they had to do was to further expand the number of stores and then float the company to make a handsome return. Financing this was simple, or so they thought; just cut stocks and extend the payment terms to suppliers.
However this disrupted the flow of credit which removed the business' competitive advantage. The business rapidly lost market share, plunged into losses and eventually into administration and the shareholders lost everything.

Two black holes for the price of one

Has the recession made things worse? The continuing tight credit conditions won’t have helped but there is a more deep seated problem in the banking sector that is reinforcing the late payment culture and making it part of the problem.
Last week Sir Mervyn King, Governor of the Bank of England warned that the banks have significant amounts of undeclared losses on their books from loans that are just never going to be repaid.  He pointed out that this is a significant drag on the economy. Until banks own up to this black hole in their balance sheets and are fully recapitalised we will not be able to return to the levels of banking provision we need to drive economic recovery.
Many of these bad loans are with creditors who are managing to survive and pay the interest on their loans but are unable to repay the principle. Moreover in order to survive they pay their trade creditors as late as they can.
The inability of banks to deliver adequate banking provision also means that many viable businesses just cannot get the finance they need from their bank to grow. Many are then forced to push out their own payment terms to creditors and so on through the system. There are undoubtedly some companies that are accumulating cash at the expense of their suppliers. However there is also clearly another black hole in UK plc’s overall balance sheet, which manifests itself in the widespread and counter productive late payment culture.
The effect of all this is to disrupt the sufficient and balanced flow of credit throughout the UK business system. As the story of the retailer's demise above demonstrates, when the flow through any system is disrupted in this way it becomes inefficient, incurs unnecessary cost, fails to deliver as required and ultimately can break down altogether. We are disrupting this flow on a national scale with the inevitable adverse consequences for economic growth.

And the solution is ...

Right now I don't have a solution to offer. Clearly clamping down on all the bad loans in banks' balance sheets too quickly risks Armageddon  However what I do believe needs to be done first is to recognise the problem and get to understand it. So this is not about coming up with one off schemes like “supply chain finance” that do little or nothing to address these two fundamental weaknesses in our economic and business system. Government has a key role in this and part of that role is to set the parameters for the UK business system. That in turn means deciding whether doing business in the UK means that on time payment to your creditors should be part of those parameters or not. Only then are you in a position to start devising effective solutions to bring this about.

So that was some of the week before this week. We hope you found some of the above thought provoking and useful for you and your business. We trust you had a good weekend and hope you have a great week this week.

1 comment:

  1. The supply chain finance scheme must have been thought of by a moron. Surely a copy of a purchase order sent to the bank would have been fine. How much will the MNC's charge the SME's for the letter - extra credit days, larger discounts?