Late or irretrievable payment from suppliers and clients are perennial headaches that keep business owners awake at night. And with other ever-present challenges – including economic headwinds, competition and fickle consumer sentiment – conspiring to stymy business growth, life as a business owner operator is certainly tough.
But tough does not mean growth is impossible – particularly as there are new tools to help combat the scourge of late payments, otherwise known as bad debt. And make no mistake, the chances of bad debt occurring for small businesses is rather high, given most businesses involved in B2B sales provide goods and services on credit terms. With companies of all sizes in all sectors regularly falling into insolvency, a bad debt occurs when the money owed becomes unrecoverable.
“A bad debt doesn’t only wipe away profits, it impacts cashflow, weakens the balance sheet and takes your time away from the daily running of the business,” says Dan Chapman, Head of Surety & Trade Credit at Aon.
Almost half (49 per cent) of business failures are due to poor cashflow, according to the ASIC insolvency report.
“Most people think that businesses fail because they are making losses, but the statistics show that the number one cause of failures for small business is actually inadequate cashflow,” says Chapman.
“It just goes to show that cash really is king.”
While managing cashflow can be a difficult task on its own, a significant proportion of small business aren’t credit insured so the impact of a large bad debt or a string of smaller bad debts can be significant and potentially lead to insolvency.
“Bad debts can impact businesses operating in any B2B sector but in the current economic environment those selling into the construction, retail and agriculture sectors are the most at risk,” says Chapman.
And this risk is magnified when businesses have a high concentration of sales to a small number of clients.
When RCR Tomlinson – a major engineering firm that was once valued at almost $1 billion, fell into administration – over $250 million was owed to 4000 creditors. Aon successfully processed client claims ranging from $20,000 to over $9 million.
“When a client fails, a trade credit policy reacts to help ensure you get paid for the goods and services that you have supplied,” says Chapman.
Trade credit policies are designed to provide a safety net against unexpected losses and also help avoid losses altogether. The insurer employs a team of analysts who review the credit profile of a business’ clients and monitor financial information and payment experience. This process helps to identify and avoid trading with businesses that are distressed. If a client becomes insolvent, the policy will typically cover up to 90 per cent of the outstanding amount to make sure that a business can continue unaffected. Most insurers will also provide contributions towards collections costs for insured buyers.
“Trade credit insurance is often overlooked by small businesses because they think it will be expensive and complicated to manage,” adds Chapman.
Not just for conglomerates
To demystify the product and make it more accessible to the small businesses Aon has partnered with a leading insurer to design Debt Protect – a simple, low cost option aimed at business with revenues up to $50 million. The option offers a transparent pricing model, based on turnover to make identifying a company’s premium easier. The policy includes reduced credit limit fees, fast tracked claims process (up to $40,000) and an integrated collections service with up to 100 per cent costs covered dependent on level of coverage.
“Each time you sell goods or provide services on credit there is a risk that your client isn’t going to make payment,” says Chapman.
And while there are lots of actions a business can and should take to improve its odds of receiving funds, including careful selection of customers, rigorous credit controls, sensible terms of payment and prompt collection actions – none of these will guarantee success.
“Credit insurance provides a safety net to business when these other measures fail, the question businesses need to ask themselves is can they afford not to prepare for potential bad debts?”
The policy can also be used to confidently grow a business’ product and service offering.
“A key benefit is giving company directors and owners time back in their day, to worry about the things they need to be worrying about, rather than bad debt,” says Chapman.
Whereas previously, business owners may have been cautious about offering credit to a specific buyer they’ve not dealt before or wary about entering a new state; trade credit insurance can mitigate the risk.
“When you’re using a credit policy, you’ve got an insurer standing behind you who’s going to provide funds if there’s a loss. It gives you confidence to be more aggressive in making sales and therefore grow your business,” adds Chapman.
This article was written by Inside Small Business in collaboration with Aon.