After years of discussion and debate in order to combat long payment periods, habits are finally changing (almost) everywhere in Europe. Below follows an analysis of this phenomenon.
Payment periods have never been so short in Europe. Altares has published a study on the payment behaviour of companies across France and Europe over the course of the third and fourth quarters of 2016.
We learn from this report (only available in French) that the reduction in payment periods is a phenomenon observed throughout Europe. Payment periods are less than 13 days on average (for the first time since the beginning of 2008), with disparities between countries.
Germany and the Netherlands are doing even better: 6.3 and 6.5 days respectively. Belgium achieved an average of 12.6 days, which is still not bad. In the UK however, payment behaviours are struggling to change: the average payment period there is 15.8 days. But there are worse cases... Notably in Italy (18.5 days) and, above all, in Portugal (27 days).
The study notes that construction is the sector where suppliers are paid most quickly. The retail trade is also in a good position, but payment periods are still one day longer than the global average. Business services structures are significantly less disciplined, notably for non-road freight transport activities.
"Although it is certainly too soon to rejoice in a long-term change in mentalities, good intentions could be supported by the data economy and paperless business processes, starting with the invoicing chain. For example, electronic invoicing is no longer just an option." Thierry Millon, Director of Studies at Altares
What does Belgian law say about payment periods?
Belgian law specifies a payment period of 30 days between companies, from the date of receiving the invoice, the receipt of goods purchased for resale or the delivery of services. The legal payment period may be extended to no more than 60 days as long as it is agreed by both parties. From now on, in the case of late payment, the creditor can legally claim a fixed compensation payment of €40 for recovery costs.
Good to know: a single reminder for taxes
From 1 May 2017, Belgian citizens and companies will only receive a single payment reminder by post, before initial legal action in case of non-payment, including for taxes assimilated to income taxes.
How does factoring work?
The principle behind factoring is simple: you assign your receivables (invoices) to a third party – the factor – with or without cover for the risk of non-payment. When you send your invoice to the debtor, the factoring company can pay an advance of up to 85% of the amount. That means you don't have to wait for payment and have immediate access to the funds. The factoring company is also responsible for monitoring and collection.
You have the option of using the following services, depending on your company's specific requirements:
Outsourcing of your accounts receivable administration
If you select this option, you assign all or some of your receivables file to the factoring company in exchange for a factoring fee. The factoring company performs the following tasks:
- entering invoices and credit notes after a thorough check and then updating the debtor data;
- checking and allocating incoming payments, including a check on partial payments and payment or invoice references;
- drafting and providing online reports and statistics, so that you always have a clear idea of the status of outstanding receivables and payments already received.
Good to know
The factoring company performs a thorough analysis before taking over your accounts receivable. It may decide to exclude some debtors contractually, for instance if they have a particularly poor credit rating, if they are natural persons or associated enterprises, operate in countries with a high default risk or have stated that they do not wish to pay via factoring.
Monitoring and collection of your outstanding invoices
In this case, the factoring company is responsible for collection of your outstanding receivables and following up on debtors by phone and with written reminders. This means you have more time to build up good relationships with your customers.
In practical terms, you issue your invoices and send them electronically from your accounting program to the factoring company, which is then responsible for collection and follow-up. Because of its expertise and experience, the factoring company is generally able to collect payment of the invoices 25% more quickly than your own accounts department. And as a third party, it is often more successful when it comes to payment notices.
You can track the entire process via an online application, so you are always aware of changes in your receivables portfolio. For instance, you can consult detailed information on your outstanding invoices, credit notes, payments and disputed payments at any time.
Advances based on the amounts of your invoices
In addition to outsourcing their receivables management, many companies that use factoring also call upon advances based on their outstanding invoices.
In this case the factoring company advances a percentage of the invoice amount (usually between 75% and 85%) immediately after receipt of the invoice. You receive the balance when the debtor has paid the factoring company. You pay interest on the amount advanced.
This form of advance has distinct advantages:
- You generate additional working capital on the basis of your outstanding receivables.
- You improve your cash position, so it is easier to invest or enter new markets. In addition, as a quick payer you can request healthy discounts from your suppliers.
- There is a direct link between your available funds and turnover growth: more sales means more funding for your company's continued growth.
Cover for the non-payment risk
Factoring companies offer various packages so that you can obtain 100% cover for the risk of non-payment of your outstanding invoices. That means you don't have to worry about the possibility of your debtors defaulting. This additional certainty of payment also makes it easier for you to offer more flexible payment terms, which could give you a considerable competitive edge.
The following risks are covered:
- Proven insolvency, for instance as a result of bankruptcy or judicial settlement.
- Probable insolvency: when the debtor has still not paid within a contractually agreed deadline after the due date of the invoice (usually ninety days).
If one of your debtors defaults, the factoring company will pay the entire amount of the invoice, within the predetermined credit limits, within the agreed deadline after the due date of the invoice.
Good to know
A credit insurance policy is also particularly useful to safeguard your export transactions.Through the credit insurer, you have access to:
- information on the credit ratings of your foreign debtors
- information on the specific risks associated with the country of destination
- bank and customs guarantees with your foreign trading partner
- a collection service if your foreign debtors don’t pay their invoice
Working capital: far more than just an accounting term
Working capital, also known as net operating capital, presents a picture of the operational liquidity of a business. But there is more to it than meets the eye.
The success of a business actually depends to a significant extent on how it deals with its working capital needs.
The difference between working capital and working capital needs
Within the financial analysis, working capital is just one of the indicators that present a picture of the operational liquidity of a business. It not only affects general management, but also the access to bank credit or the valuation of the business, for example. This is calculated as follows:
Equity capital and other resources in the long term - fixed assets
This allows you to see whether sufficient long-term funds are available to finance the production chain. Where there is a positive result that is indeed the case, whereas with a negative result it is actually the production chain that must safeguard the long-term financing.
It is therefore useful to calculate the working capital needs as well:
Current assets (excluding cash) - current liabilities (excluding financial liabilities)
The result shows the amount the business needs in order to finance its production chain, and may be both positive and negative:
- where working capital needs are positive, the commercial debts no longer cover the short-term assets (excluding the financial). In that case, a business can rely on its working capital. If this is insufficient, it will need additional financing for its operational cycle in the short term;
- where working capital needs are negative, a business can meet its short-term liabilities without any problem. Nevertheless, it is advisable to reduce working capital needs (further).
In short, working capital presents a picture of the operational liquidity of a business, whereas working capital needs represent the amount the business needs in order to finance its production chain.
In other words, it boils down to limiting working capital needs as far as possible, thus increasing liquidity. This is crucial, especially in times of economic or financial difficulty. After all, customers tend to pay later then, while your stocks are increasing and your suppliers are imposing stricter payment terms. As a result, more and more working capital gets 'frozen' in your operating cycle, precisely when circumstances make it more difficult to attract additional financing.
Optimising working capital is not only a question of long-term considerations. In the short term, too, the business can release cash that is not being used optimally, or is being used unnecessarily, more specifically in the purchasing, production and sales processes within the operating cycle.
The working capital and the working capital needs must, above all, be geared effectively to each other. The working capital needs must be structurally less than the working capital itself, preferably with an extra buffer. However, there is no mathematical truth regarding the amount of working capital and working capital needs. Sector, activity and business model can affect this, for example.
The cash conversion cycle reviewed
A good barometer of how great the demands of your operating cycle are on your working capital is the 'cash conversion cycle'. This is expressed in number of days and shows how long money is tied up in your business's purchasing, production and sales processes.
The calculation of the cash conversion cycle is based on:
- the number of days' customer credit (DSO – Days Sales Outstanding):
the average number of days that your business must wait for payment after a product or service is delivered.
- the number of days' stock rotation (DIO – Days Inventory Outstanding):
the average number of days that your business needs to convert stock into a sale.
- the number of days' supplier credit (DPO – Days Payable Outstanding):
the average number of days that your business needs to pay suppliers.
The shorter the cycle, the less capital is held in the business process, which allows you to meet your short-term liabilities and expand your activities.
Simplified presentation of the cash conversion cycle
4 rules of thumb to get your working capital working for you
Although entrepreneurs are familiar with the term working capital, all too often they fail to use its full potential. This is a mistake, because targeted management of their working capital needs can bring huge advantages, both financially and at an organisational level.
How a business approaches that in practice is obviously closely linked to its own specific situation and the sector in which it operates. Below is a number of general rules of thumb:
1. Analyse your business processes
A logical first step is a thorough analysis of your working capital needs, based on the cash conversion cycle. The idea is to clearly identify the following business processes:
- management of your customer payments
How long does it take before your invoices are paid? Why do some invoices remain outstanding? How aware are you of your customers' financial situations?
- management of your supplier payments
What payment terms are you getting? Do you get a discount if you pay quickly? Do you use advance financing?
- management of your production and stock
How far can you deplete stocks without jeopardising production? Can you shorten the production time in order to reduce the amount of work in progress? Do you work according to the Just-in-Time system or have you decided to go for Economic Order Quantity?
You will then find out where there is room for improvement and how you can shorten the cash conversion cycle. The idea is to reduce your working capital needs and, by doing so – by dealing more frugally with the available capital – increase the return from your general management.
2. Collect faster and better
Adequate monitoring of your accounts receivable is crucial. Relatively small, obvious interventions can sometimes produce a surprisingly big benefit. Here are some tips:
- Monitor the quality of your invoices. A good invoice will quote a correct amount, a payment due date and will be received promptly by your customers.
- Invoice smaller amounts on a regular basis and avoid summary invoices where possible.
- Actively follow up outstanding invoices and find out why they remain unpaid. Is it down to the customer's financial situation or are there other factors to consider? Disagreement over the amount charged or problems with the delivery or sale often cause delays or result in non-payment. By aligning your accounts and services more efficiently, you end up with a win-win situation: satisfied customers and fewer disputed invoices.
- Solutions such as factoring or direct debit are a particularly profitable route to take. These lead to swifter collection without putting pressure on your customers or tightening up your payment terms, which is always delicate in a commercial relationship.
A clear picture
Without an overview of your accounts at home and abroad and of your incoming and outgoing payments, management of your working capital is virtually impossible. So, you need clear, immediately available information and reporting. Different solutions for electronic banking, reporting arrangements with your financial partners and efficient operation of your accounts and bookkeeping will help you considerably here.
Another profitable route is the centralisation of your cash and cash equivalents, which will dramatically simplify both the management and monitoring of these. Often this also offers numerous options in terms of fiscal optimisation.
3. Make optimum use of your supplier credit
Making sure your invoices are paid systematically in order to build up your number of days' supplier credit seems a painless and effective intervention, but it is the least you should do. After all, there is a good chance that the supplier will pass on the charge for the longer payment term in the price you pay for subsequent deliveries. There are a number of better alternatives:
- See whether or not it would benefit you to pay more quickly – in many cases early payment carries an attractive discount.
- Choose solutions that let you pay later without the other party being affected. For example, by relying on lines of credit or working via reverse factoring, whereby the supplier receives an advance on your payments from the bank.
- Negotiate with your supplier for an extension to your payment terms.
Ensure you have adequate protection
Being able to get hold of your funds quickly is just one aspect of optimum management of your working capital. Another is the assurance that your customers will actually pay, while at the same time your business must project confidence to (potential) trade partners. To that end, you can call on the various forms of documentary credit. By engaging credit insurers, you are also hedging the risk of the other party defaulting on payment.
Another important factor, certainly as far as international transactions are concerned, is the exchange rate risk. Although you may know when you are going to get paid, the exact amount depends on the exchange rate at the time of payment. Because the difference between a good and a less favourable exchange rate can have a big effect on your margin, you are better off hedging yourself against possible exchange rate fluctuations.
4. Get maximum performance from your stocks
The financial impact of your inventory control should not be underestimated. Just think about invoices that are outstanding after a faulty or late delivery, or holding on to too much stock of slow-selling products. The advantage of the latter is that you can always deliver promptly, but it does freeze a major part of your working capital. A few guidelines:
- Check your stocks and prices regularly, preferably using a package like Enterprise Resource Planning (ERP) or a web-based application with direct link to your opposite parties.
- A warehouse management system will allow you to retain a good overview of your quick and slow-selling products, so you can adjust your stock accordingly.
- Keep your finger on the pulse of the market so that you can correctly assess demand, and thus avoid stock surpluses or deficits.
- You can also choose a radically different course and outsource your stock management to a logistics service provider.
- Use stock financing to keep cash and cash equivalents available for other purposes.
- Hedge yourself against price fluctuations on the raw materials markets, to protect your margin.
An exercise in balance
Optimising your working capital needs is therefore a continual exercise in balance between your accounts receivable, accounts payable and inventory control. It is a stiff challenge, but essential if you are to increase your financial might and steal the march on your competitors. Get your working capital to perform!