Why payment terms matter to SMEs – and the economy
Monday, August 8, 2016/
Michael West recently wrote a great article on payment terms. The Australian Small Business and Family Enterprise Ombudsman (ASBFEO) is onto this topic as well and has taken submissions on changes to payment terms and their impact on small business.
I made a submission to the ASBFEO because I think this is an area that is crucial to small and medium business. My submission looked at the actual changes in debtor days for six of my clients over the last three years.
There are countless anecdotes running around about what is happening, and I felt a submission that looked at actual experience would add perspective, even if it is only the actual experience of a very small number of businesses.
Here is what I found.
The experience was idiosyncratic across the 6 businesses (no surprises there really).
When taken as a weighted average of all six businesses, debtor days had mildly increased over the two-year period from 54 days to around 57 days.
There is noise in Graph 2, from a seasonal business (Company 4 in Graph 1) and a business that grew rapidly in the last third of the review period (Company 2 in Graph 1). When I removed these two companies from the series, the weighted average debtor days of the remaining companies reduces from 55 days to around 50 days.
Interestingly, Graph 3 shows a similar picture to the graph of Average Invoice Payment times in this release by Dun & Bradstreet. Clearly, their sample size is significant and thus it can be concluded that the trend in payment terms experienced by the four businesses that make up Graph 3 was a “typical” experience.
On the face of this information you could conclude that in aggregate, there is no problem with payment terms in Australia. Payment timeframes are speeding up.
But this misses the point.
The real point is that payment terms of ~50 days are a significant barrier to SME growth.
Let’s put some statistic on the table. According to the Australian Bureau of Statistics, as at June 2015 (the most recently available data):
- Small and medium size business employed 68% of Australians;
- Small and medium size business generated 55% of total industry income, 66% of total industry profit and 57% of industry value add; and
- These figures have been quite consistent over the last 7 years.
Therefore, SME businesses contribute more to the economy in terms of employment and economic growth than large business.
Now, let’s take a look at Company 2 (the growing business in Chart 1) from the data set. Here is what happened:
- Over a four-month period (September 1, 2015, to December 31, 2015) this business increased its annualised Sales by $2.4 million.
- Over the same period that growth resulted in its debtors increasing in value by $3.1 million. Its debtor days slowed from 55 (about the average for the clients in my small sample) at the start of its growth spurt to 102 days four months later.
This business needed to find that $3.1 million to fund this growth. Luckily, it had a supportive bank and was able to get that funding.
I wondered though, what would have happened if Company 2 was collecting its debtors on a 30 day basis instead of a 55 day basis. So, I crunched the numbers and worked out that the increase in the value of its debtors was much lower, at $1.6 million.
The message I take from this is that the capital required to fund the growth of an average business reduces by a factor of two times if payment terms are sped up to 30 days.
So, for a business supplying any of the large companies identified in Michael West’s article, the capital they require to fund growth would reduce by a factor of between three and four times.
Considering that SMEs contribute the lion’s share of employment and economic activity I think a reduction in the capital requirement to fund growth by a factor of between two and four times is significant.
I know there has been some help for SMEs in the last two federal budgets. In reality, this help is modest and frankly, and not likely to stimulate much in the way of employment and economic growth. You can read my budget analysis here.
However, imagine if all businesses had to pay each other on a 30-day basis – as West points out this has been law in Europe since 2013. Imagine you are the SME owner and you are able to say to your bank that the repayment of your funding need is underpinned by an invoice to a major multinational that is payable in 30 days time. I reckon the banks would fall over themselves to do that piece of funding. Growth would be easier. Jobs would follow.
You know the best bit – it would not cost the federal budget a thing, and would probably contribute to it through higher company income and Pay-As-You-Go income tax receipts. Just a thought …
Michael Stapleton is a founding member of the Association of Virtual CFOs. He operates a Melbourne-based Virtual CFO practice, helping owners of small and mid-size businesses understand the drivers of their cashflow and make financially informed decisions. Find out more about the Association of Virtual CFOs on LinkedIn.