The European Parliament’s Internal Market Committee (IMC) has recently proposed changes to the EU’s directive on late payments which are designed to give more protection to businesses – especially small to medium sized enterprises (SMEs).
The IMC wants to introduce a mandatory maximum payment term of 30 days for all transactions, whether between the public sector and private companies or business to business (B2B).
The recommendations allow some leeway for extension. In B2B transactions, the extended period must be stipulated in the contract and could be further extended if it doesn’t cause unjustified financial harm to either party.
For public sector bodies, the rules are stricter: there must be an exceptional reason to delay payment beyond 30 days, while 60 days is the absolute limit.
There are recommendations too for interest payments and compensation for late payment.
The directive and its proposed amendments are no doubt well intentioned. But the question is ‘Will they help cash strapped SMEs – or, for that matter, larger companies?’
The concept of maximum payment terms definitely has merit, particularly when it comes to public bodies. The latest Atradius Payment Practices Barometer (downloadable from www.atradius.com) shows that, in several European countries – notably the Netherlands – public sector bodies were judged the worst payers.
Looking further, there are other potential benefits:
– Increased incentives for cross border trade
– Fewer misunderstandings about international payment terms
– Better payment predictability that can increase supply chain management and maximise manufacturing run efficiency
– More disciplined purchasing
– More efficient procedures for collecting overdue payments
– Room for flexibility in setting terms of payment
However, legislating a maximum credit period of any number of days doesn’t necessarily guarantee timely payment, which still needs to be effectively managed by the supplier. Bear in mind that the party struggling to maintain its cash flow is just as likely to be the buyer as the supplier, so the possibility of a late payment still exists, no matter what the payment term.
The length of the credit period does not itself determine healthy cash flow: if the agreement does not put financial stress on either party and the supplier is confident of receiving payment on time, cash flow can be managed through intelligent credit management and by maintaining a portfolio of trusted customers.
A recent Atradius white paper, The future of trade credit, (www.atradius.com) actually found, by surveying businesses operating across Europe, the USA, Australia and New Zealand, that the majority of respondents expected credit periods to extend in the next 12 months to allow customers more time to pay. As the world recovers from the economic downturn, bank finance – especially to SMEs – is still hard to come by, and the credit period allows customers time to raise the wherewithal to pay for their goods and services.
As one of the contributors to the white paper, US based credit consultant Abe WalkingBear Sanchez, put it: “While the supply of money is limited by how much of it governments print, credit is unlimited; in fact, the more of it that is extended the greater is the demand created for products and services. Credit, properly understood and managed, allows the expanded movement of products and services and for economic growth and prosperity. Credit is a lubricant of commerce and greases the wheels of business.”
And, whether it is the supplier’s or the buyer’s cash flow that the EU directive seeks to protect, a short credit period may in some circumstances exacerbate the situation. In his article ‘The recession conundrum’, also quoted in the Atradius white paper, Rob Sherman expresses the following piece of absolute common sense: “Even the most meticulous accounts receivables efforts are ineffective if your customer simply does not have the financial means to repay their debt. So rather than fight a fruitless war, progressive finance departments are instead offering innovative solutions to their customers.”
What needs to be understood is that late payment and the agreed credit period are two separate issues, and the parties to the sale must decide on the best way to achieve a mutually successful transaction.
In his article, Sherman hits upon the salient point that perhaps lies ‘between the lines’ of the directive: that trade credit isn’t simply a term of payment – it’s an expression of trust and a means of fostering successful long term business relationships. And, in a competitive market, retaining good customers should be every business’s top priority.
Simon Groves is a senior manager of corporate communications and marketing at Atradius Credit Insurance NV