Risk management: down with debt

Is it time for firms and in-house practitioners to adopt the role of financial futurologist? Should the accountancy industry increase the scope of value added services offered, accurately predicting future liabilities and offering consultancy on active capital and cash flow management, based on current and future trends rather than historic data?

There are significant untapped revenue streams to be earned from financial risk management consultancy, focussing on active financial management to supplement traditional, historic data analysis, especially for external consultants.

Debt management and identification of risk in many firms is still related to their own experience of an individual customer’s payment record. This blinkered approach ensures that thousands of clients each year experience significant write downs, or even go to the wall, because of an over reliance on retrospective audits rather than active financial management.

Too often external accountants are still employed merely to review historic data, mitigating tax liabilities and establishing monies owed to HMRC. Given the pressure on the accountancy sector, there is an opportunity for firms to look beyond audits
and end of year returns to offer active management services in areas such as working capital, cash flow management and de-risking payments.

One such service would be to identify the extended payment ecosystem for a client, identifying all the firms they trade with and ideally the financial health of the customers of their clients. While these firms may not directly trade with an enterprise, they may still rely on monies being paid forward through the business ecosystem. All too often in the business world, we see a catastrophic domino effect when one firm encounters financial difficulties.

If company X either goes bankrupt or cannot meet its liabilities, this can affect the ability of company Y to pay company Z. Company Z never had a relationship with company X but its financial health is intrinsically linked to this company.

Accountants can act as an early warning system, alerting their clients when the credit rating or payment profile of a company linked through the business ecosystem changes markedly. Some firms have significant exposure to single clients, so it is vital to the de-risking of their businesses to establish the health of these trading partners. This should be of particular concern for firms that are overly leveraged on supplying goods and services to the public sector, given the stated ambition for government departments to reduce their budgets by up to 40%.

At present, a significant number of firms only start to provide for ‘bad debt’ and change their forecasts if monies have not been received following the 60-day or 90-day payment period. These monies may have already been assigned to cover expenditure or liabilities and end up taking months to come into the business, or sometimes don’t come in at all.
This lack of planning and visibility can be the death of a business, especially if they do not have adequate capital reserves or credit facilities to cover the shortfall in monies received.

Recognising a company cannot pay two months after an invoice has been issued may be too late for some firms if they are relying on these funds to make adequate contingencies, such as shoring up capital reserves to meet any deficit.

The credit referencing industry has developed beyond recognition from delivering credit ratings alone and now delivers comprehensive business intelligence solutions and data that can be employed as early warning systems.

In addition, these services provide an insight into the international exposure of a business through the subsidiaries and parent companies of trading partners. An operation in the UK may be entirely solvent, but failing to investigate its exposure to other parts of the business based overseas is only viewing a single piece of a complex globalised jigsaw.

Using credit referencing services to constantly monitor the ratings of an organisation’s customers on a regular basis, firms can reduce their exposure to bad debt provisions. If a finance professional has insight that a customer is unlikely to meet its obligations, he or she can advise on tangible steps to mitigate the risk to the enterprise.

They could call in debt, offer an incentive for immediate payment, or reorganise their cash management so they are still able to fulfil their obligations should these funds not materialise. Accountancy firms offering this service can increase their own revenues and generate monthly fees to smooth out the traditional peaks around year end filings and troughs during the summer months.

Many enterprises may be lulling themselves into a false sense of security that their exposure to bad debt is diminishing because the number of companies entering insolvency is falling. It’s true that the volume of company liquidations has dropped, down to 4,082 in England and Wales in the first quarter of this year. However, when assessing this downward trend it is vital to recognise that, in the period being benchmarked against, Britain was still in the middle of recession. So, while companies may feel the threat of late and defaulted payments is receding, closer analysis may reveal a time bomb waiting to explode.

There are currently a significant number of enterprises that are receiving monies under the government’s emergency rescue schemes who may actually be sleep walking into insolvency, with trading partners unaware of the true scale of their customers’ liabilities. Over 200,000 businesses have entered Time to Pay arrangements with HM Revenue & Customs since the end of 2008, deferring at least £5.2bn in business taxes.

This means there are hundreds of thousands of businesses often unwittingly trading with enterprises that are struggling to meet their financial obligations to the Exchequer. While the majority of these tax monies are repaid, the taxman reports that 10% of expected revenues are outstanding. Accountancy firms and in-house practitioners can add value by identifying clients’ trading partners and customers that have entered into this scheme and therefore at greater risk of insolvency.

Finance professionals can also expand the scope of their influence within an organisation by offering strategic consultancy on revising front office business processes to mitigate the risk of bad debt. As a first step, they can drive operational change advising departments from sales and marketing to procurement to use credit referencing services. Teaching personnel throughout an enterprise to use business intelligence solutions, such as company credit reports with ratings and proposed credit limits, can ensure resources are targeted effectively.

For example, if a company has a proposed credit limit of just £500 but wants to order stock worth £10,000 it should be a red flag to the sales manager, who could decline the sale or request payment in advance of delivery.

Giving access to resources that have previously sat predominantly within the finance function can dramatically improve cost controls and efficiency within an organisation. In doing so, sales and marketing or procurement resources will become more targeted as potential customers that could become late or defaulting payers are identified prior to contract signings. The term ‘back-office’ has been a millstone around the finance and accountancy profession’s neck for far too long: perhaps this is the perfect opportunity to revise the front office by re-engineering business processes and reducing demand for deficit financing to cover delayed and defaulted payments.

The transition from accountant to financial futurologist, or financial management consultant, requires a commitment to use new technologies and adapt working practices. However, for external firms developing a proposition to constantly review client’s finances in real-time and more accurately forecast future liabilities, it can provide a welcome source of new revenue.

For the in-house practitioner using credit referencing solutions to more accurately forecast can help them dramatically reduce their firms’ exposure to bad debt. Accountants can make the risk of ‘bad debt’ pay for them if they are prepared to embrace change and position themselves as a front-office necessity.

David Knowles is business development director at Creditsafe

Bad excuses

Here are some of the more outlandish reasons given for not paying invoices:

“I’m too important to read my post, so why would I know you billed me.”

“Our accounts lady is off at the moment as her cat died.”

“My husband has my cheque book and he has now been put in prison.”

“The finance director had a heart attack due to stress and can’t sign cheques in hospital.”

“The customer couldn’t get into the office to get the cheque book because the locks had been superglued by travelers.”

“The goods were signed for in a different colour pen to the one our warehouse manager normally uses, so we have to check it was definitely him who signed for the merchandise before we pay you.”

“My wife has gone off to look after the grandchildren for a week and taken the business cheque book with her.”