Small and medium sized businesses employ 7 million Aussies (70% of workforce) and generate over 50% of GDP. Yet 40% fail due to poor cash flow and 57% of businesses borrow money to fund their working capital needs.
I have painted a pretty dire picture here but it is as serious as it sounds! That is why the Coalition Government has pushed its Innovation Policy to aid and boost start-up and SME development. Our government has finally realised that for Australia to remain competitive in this post-mining boom era, we have to focus on the vast diversity of businesses that keep the cogs oiled and the lights on. Lets hope they can deliver.
So why do SMEs struggle to survive?
There are two main issues - lending availability and long-payment culture. Lending for SMEs has improved considerably with alternative funders picking up the slack from the banks. We cover this in more depth below. Long-payment culture is the elephant in the room. Big business uses their supply chain as a first-port-of-call for cash flow as it is the cheapest and seemingly easier source of capital. Only recently did Kate Carnell, Small Business Ombudsman, come out and highlight the severity of the issue by commenting that “large companies are treating small suppliers with contempt” and she is considering an inquiry.
So how did the bad of behaviour long/extended payments become a culture of habit?
Imbalance of power
Our economy is dominated by various oligopolies across key sectors. Retail, mining, grocery, media and IT industries all have inherent long-payment cultures with terms usually sitting on 60 days. This concentration at the top cultivates an imbalance of power so big that companies use their supply chain as line of credit. A supplier doesn’t have the luxury of going somewhere else in these concentrated supply chains so are at the mercy of the big buyer.
Cheap source of capital
When a business (big or small) needs to boost its working capital, commonly the first port of call is their supply chain. Negotiating or commanding longer payment terms for a discount is an opportunity cost for the business if the ‘free cash flow’ can be used to generate greater return on investment. Big companies, especially publicly listed ones, often leverage this opportunity to boost free cash flow to bolster the strength of the balance sheet. Free cash flow is a key driver to the company's market value and is a term heavily scrutinised to by market analysts when assessing financial integrity. Hence the reason the supply chain is so heavily relied upon. Push out payables, hold cash and don’t take on debt. It is a “no brainer” from a business management perspective. Basware interviewed 1000 large companies worldwide with the following findings:
“While the vast majority (88 per cent) of respondents agree that suppliers should be paid promptly, over half (57 per cent) admitted to having actively delayed payments in the past 12 months”
“Two thirds (67 per cent) acknowledged that they have used payment terms as a strategic lever to help manage cash flow”
Unfortunately the ramifications for these tactical decisions impact the supply chain immensely with the cash payment delays having a snowball effect to suppliers down the line.
Inefficient Supply Chain Management infrastructure
Supply chains are complex beasts that need sophisticated systems to organise and coordinate with product life cycles. There are a plethora of Electronic Data Interchanges (EDIs) servicing supply chains with data transfer infrastructure for a product life cycle but the main problem is the lack of collaboration between these independent systems leading to massive information asymmetry between suppliers and their customers. Furthermore, many sector supply chains don’t even use electronic means to transfer information: paper is still in heavy use in many supply chains. In Australia, electronic invoicing has been adopted for only 15% of total trade. Countries like Brazil, Norway and Sweden have 80-90% adoption with their economies capitalising on massive efficiency gains.
Dealing with this Long Payment Culture
It is hard to change long-standing culture without time and investment. SMEs unfortunately don’t have this time so what is being done to fix this problem?
Prompt Payment Protocol
Australia is following the UK’s lead with the introduction of a Prompt Payment Protocol to push big companies to toe the line and pay in less than 30 days. Sophie Andrews from The Accounts Studio, thinks it is a game changer if adoption is alike to the UK.
"The UK introduced a Prompt Payment Code (PPC) back in 2008, and all signs show that signatories are now paying up to 12 days quicker. Even more importantly, the analysis indicates that signatories to the UK code represent over 60% of the total UK supply chain value. If and when the PPC is introduced in Australia, we hope to see it reach at least 60% of Australian businesses, if not more, to make a significant difference.”
We are big supporters of this reform but fear the motivations and in turn the level of adoption by big Australian companies will be slow given the huge impact it will have on their cheapest and most easily accessible line of credit - the supply chain. These companies report to shareholders and are mandated to generate cash flow in the most cost-effective manner. Are reputational risks large enough to justify a change in cash flow management structure? It could take years to gain awareness and adoption of more streamlined cash flows; that doesn’t help SMEs today.
Electronic Invoice Reform
Electronic invoice reform is not the most exciting topic of debate but is one that should be taken seriously in Australia. With e-invoice adoption is at 15% compared other countries where adoption ranges from 75-90%, approximately $5bn in efficiency gains could be achieved if a standard framework was introduced. This is just the tip of the iceberg when considering the efficiency gains and commercial opportunities a centralised framework for invoices will provide.
Fortunately a central framework is being currently designed and debated by the Digital Review Board that will mandate all invoices to be process electronically through one central location in order to make the flow of invoice information more efficient, transparent and trustworthy. The successful role out of such an initiative is advantageous to all stakeholders with efficiency gains reducing operating costs and less information asymmetry mitigating fraud and non-payment risk. This in turn creates more stakeholder accountability. Strong adoption of e-invoicing in Brazil (approximately 90%), has saved Coca Cola 70% in operating costs since 2014.
Alternative Finance Opportunities
Technology and innovation is playing a big part in fixing the cash flow crisis in the SME sector. There are now a plethora of unsecured short-term lenders delivering capital quickly to SMEs but such convenience comes at a premium. More interestingly, advancements in technology in parallel with the reforms that drive more transparency and trust into the supply chain, enables cash flow finance to be channelled more efficiently to the benefit of suppliers and big companies.
Suppliers are accessing more cost effective working capital when they need it via selective invoice factoring or supply chain finance. Big companies are able to maintain their terms of 30-60-90 days when a third party funding partner is paying the invoices upfront while the big company pays the funder on the date of payment. Check out our blog to learn more.
Long-payment culture in Australia isn’t going out fashion any time soon so SMEs and their trusted advisors need to get smart with how they manage invoice processing and collection. So what are some strategies to ensure clients pay invoices on time? Stay tuned!