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.”