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Managing payment delays in commercial transactions

Non-payment can be a cause of business failure

According to an article appearing in the Italian newspaper “La Stampa”, Non-payment can be a cause of business failure SME’s are the most vulnerable to failure due to non-payment. In Europe, at least one-quarter of all bankruptcies is due to delays in payment, and these defaults cause the loss annually of tens of billions of euro.

According to an estimate by the European commission, in 2000 one-fifth of business failures within the Union, were casued by delays in payment of invoices with a loss of almost half a million jobs. Many SME’s could export more product or emerge significantly on the global market if their debtors were punctual in the payment of invoices.

The companies most at risk are those which are most labour-intensive, where delays in payment have an effect principally on the vitality of the company and of its capacity to develop and invest, with a negative impact on jobs and salary payments of the workers. If this is the situation in Europe, Italy gets the ‘wooden spoon’ and beats any record. On average local bodies and public authorities pay with arrears of 12 months.

So, what happens when payment delays occur? How should a business react when faced with defaults?

What causes purchasers not to pay or to delay in making payment?

The non-payment of suppliers is the consequence of a problem which can depend on many different factors, but which are very common amongst companies:

  • Reduced consumption due to the market crisis
  • Non-sale of a large quantity of goods
  • The use of more than one supplier on the part of the big companies.

According to Unioncamere (Union of Italian Chambers of Commerce) the greater the number of suppliers which a company deals with, the greater the length of time taken to pay.

The opposite occurs where a business deals with a small number of suppliers, the payment timescale is much shorter. Unfortunately for the SME’s, it is unlikely that the big companies will change their practices, given that a large supplier-base guarantees more effective bargaining power.

What are the risks and how to defend your business from payment delays.

 Often companies, in order to maintain and increase sales, grant credit to their clients - but this is not always the most appropriate strategy to adopt. In fact, if it is true that a greater length of time to pay will attract new clients, it cannot be ignored that this will have major impact on the company itself, especially with regard to an increased costs. The company, in order to defend itself from payment delays, should know how to manage credit in an efficient and vigilant manner. A good dose of prudence and pinch of distrust is no bad thing. Requests for guarantees should always be considered among the instruments for credit management.

The risks
The granting of credit generates a risk with 2 variables:
1. risk of insolvency
2. risk of delayed payment

In their turn, these risks generate costs linked to:

  • credit management and debt recovery
  • instalment payments

How to react, and what tactics to adopt

Solutions:
Company solutions: each company has its own methods for debt collection. The latest techniques include:

  • the use of automised systems for credit management. These systems make it possible to elimate so far as possible paper files and elaborate everything through the use of PCs. The management of work is optimised through bill books and reminders, data-exchange between operators from different departments and/or legal department, reminder cards, statistics and the possibility of attaching any type of document. Everything is automised by control procedures at the expiry dates, management of collections, evaluation of risk and exposure of a client, telephone reminders, judicial and extrajudicial collections, lawyer management, generation of reports and statistics.


The more traditional solutions include:

  • telephone contact with the debtor for the recovery of the outstanding account
  • reminders by sending of messages (by fax, e-mail and post)
  • the reminder letter: this is the method by which the debtor is declared in default and, in many cases, he will pay up immediately when required or, at least, will be open to negotiating an amicable settlement
  • the division of the credit (instalment payment)
  • psychological deterrents
  • the agreement. Agreeing a payment plan/mediation with the debtor

legal action. Should the debtor not respond to reminder letters, thereby demonstrating his unwillingness to pay or, at least, arrive at an agreement (mediation) the company can initiate

legal action against the debtor. Italian Law: envisages instruments to manage and guarantee the payment of debt. Legislative Decree no. 231/2002 provides for penalty interest, which accrues on unpaid sums.

According to the Decree, in fact, debtors who do not respect payment terms agreed in commercial transactions, will be obliged to pay the interest accruing from the day following the agreed payment date or, where this is not stipulated, 30 days after the receipt of the invoice. Interest payment is triggered automatically and without the necessity for the creditor to commit his intention to recover the debt to writing, and will be calculated on the basis of the percentage fxed by the Central European Bank. The creditor therefore has the right to the payment of the default interest and the reimbursement of debt recovery costs for sums not paid, excepting in cases where the debtor is able to demonstrate that the payment delay was caused by factor not attributable to him.
Prevention: Is prevention better than cure?. When credit is granted to businesses, it is important to evaluate a number of crucially important aspects (the risks and relative costs) if the creditor does not want to run the risk of losing a large sum of money:

1. carry out checks regarding the degree of commercial reliability and solvency of the customer in order to evaluate the probability of default occurring;
2. every agreement with the other party should be made in writing, with suitable documentation in order to protect their interests;
3. furnish a suitable and safe payment instrument which guarantees the collection of the sum agreed.
4. Credit management which is personalised for each client.
Additionally, it may be useful to search for information on the debtor company consulting the following documents:

  • Company balance
  • Bank references
  • Commercial references

Remember however….
Information, even if it is reliable, can never constitute an absolute guarantee for the creditor, but serves as a guide as to how far to expose a company to risk as regards a given client.
Credit Management: There are some credit management instruments which, if used well, can become precious allies to avoid liquidity crises.

Transferred Credit: The company can guarantee a partial recovery of the debt through the stipulation of a transferred credit contract (arts. 1260 & 1267 of the Italian Civil Code). With this contract, the business cedes his credit to a third party (usually a debt recovery company), which assumes the risk of the non-payment on the part of the debtor.
The most used formula is that known as “factoring”. The party acquiring the credit and the risk of insolvency does not do this for free, but on payment. A sum is paid to the business (on average around 20-30%) less than the value of the nominal credit purchased. With the factoring the company incurs a loss, in that it has a lower return, but has immediate liquidity without have to wait a longer period to obtain full payment.
Remember that -
There also exists the formula ‘Pro solvendo or rather when the assigee answers for any default of the debtor. In this case, the contract for the creditor is less onerous, even if the assignor company will pay legal interest and judicial costs for obtaining execution of the credit.

Factoring: this is a contract which envisages the assignation of a company’s commercial credit to a factoring company which will manage such credits up until they are collected, guaranteeing the company sometimes even the positive outcome of a certain part of the operation. Additionally, factoring companies undertake to provide given services which, usually are realised in the financing of the business through advance payment of credits. It may be additionally envisaged that the Factor advances to the company a part of the credit, prior to collection. On average, the percentage advanced is around 80%, in some cases reaching 100% of the credit.
Beware of the difference
Factoring and loans supplied by the bank both in the form of payment of credits which have already matured, but have not been collected, and the payment of credits which have not reached payment date.
Resorting to a factoring contract is limited only to the assignation of pecuniary credits by a business in favour of a company which is able to offer particular guarantees from the patrimonial and professional point of view.

The discount: is the contract with which the bank advances to the client the sum of a credit, which is not yet expired, by way of assignation, subject to payment, of the said credit. Two elements require to be considered with particular attention: payment of interest and the “subject to payment” clause. So far as the interest is concerned, it should be said that the percentage varies according to how reliable the bank considers the debtor company to be.
The “subject to payment” clause means that in case of the debtor’s insolvency, the company which has effected the discount operation must pay to the bank the sum required. An operation which must be used by the company with considerable attention, verifying the reliability of the debtor company. In fact, if the latter does not pay, the company will be forced, after having paid interest, to repay the sum advanced by the bank.
Credit manager: For every company or commercial activity a useful way of confronting the payments problem is that of having a credit manager at its elbow. This is a professional who can follow the whole process, from the constitution of the credit right through to its payment and who is able to act in advance (recent credits have a higher possibility of being settled in the extra-judicial phase) and of utilising all the instruments of guarantee envisaged by the law. Even if it is a figure more readily employed by medium to large companies, even SME’s could benefit from the support of an expert.



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