Pre-emptive risk assessment and other long-term strategies are often sacrificed due to a need to get on with the daily running of the business. The significance of this issue becomes increasingly clear when you consider that over one million businesses fall into the sole-trader category. Yet the financial consequences for a business that fails to factor risk into its practices can be severe.
Keeping the cash flowing
One of the key goals of risk assessment is to make sure cash keeps flowing in the door. When we consider that trade creditors are the unseen bankers of our economy, trade credit naturally becomes the first port of call when a firm looks to manage its cash flow.
For instance, last quarter alone almost $6 billion dollars was held up in delinquent trade payments. Recent analysis of D&B’s trade data found average business-to-business payment times currently sit at
52.6 days. Essentially, this means Australian businesses are breaching the standard trade credit term by over three weeks. This inevitably creates a ripple effect, as businesses waiting to be paid may themselves be unable to pay suppliers. This places tremendous pressure on business cash flow at both ends of the payment cycle.
During the March quarter this year more than 120,000 businesses suffered a delinquency rating downgrade based on D&B’s Dynamic Delinquency Score (DDS). These firms now represent an increased risk of tardiness with trade accounts in the future which, taken together with related factors, contributes to a firm’s overall risk rating.
The need for due diligence
Ideally, a small business owner should approach every potential supplier with a level of caution before they extend credit. Just as a bank performs adequate background checks on a business or consumer before loan approval, diligent SMEs should also ensure suppliers are in a good fiscal position prior to the establishment of an ongoing credit relationship.
Small business’s trade debtors are often small businesses themselves, so understanding the risk associated with this demographic is key to unblocking SME cash flow. Our analysis of more than one million unincorporated small businesses revealed hundreds of thousands fell into a high risk classification. This means these businesses are 12 times the insolvency risk of other unincorporated entities. The ability and propensity of an SME’s trade debtors to pay their bills on time can impinge on the small business creditor’s ability to pay wages, rent and other critical overheads on time.
Further analysis of small entity business-to-business payment behaviours found those falling into the ‘severe’ risk category were 2.5 times more likely to pay trade accounts delinquently. Similarly, businesses in this category were 12 times more likely to take 120+ days to settle trade accounts.
Not all bad
During the process of due diligence, however, the good is uncovered alongside the bad and the same analysis found 714,000 of these businesses do not have an extensive financial obligation. Likewise 650,000 have no adverse information on file and over half a million have zero or one recent credit enquiries, meaning they would qualify for credit faster than a firm with four or more recent enquiries.
SMEs vulnerable
Small firms, like all businesses, are in many ways at the mercy of their accounts receivable. While maintaining cash flow is vital for all businesses, the key difference for the SME is that low cash flow will invariably place more pressure, more rapidly, on operations than would likely be the case for big business. Smaller operators will often engage in far fewer trade relationships than larger companies, and while this helps simplify the risk monitoring process, it also highlights the level of dependence on individual customers. This places far more emphasis on the ability and inclination of each customer to pay bills on time, only increasing the significance of trade-related risk mitigation.
Most SME owner-operators are unincorporated, work from home and employ few or often no staff and as a result owners can become mired in frontline operations. Monitoring the risk of current and existing suppliers is the most efficient and timely way for SMEs to monitor risk. Trade data is frequently updated, making it one of the best barometers of business health and performance.
