Credit where credit's due

SMEs must be more financially transparent if they want credit companies to take risks with them.

The government has launched a White Paper to modernise and simplify company law. While the intention to reduce the amount of red tape faced by small businesses is commendable, it may actually have a detrimental effect.

Modernising Company Law, which was published in July, proposes the turnover ceiling for small to medium-sized enterprises (SMEs) should be raised from £2.8m to £4.8m.

Firms that turn over less will be required to file only simplified accounts to Companies House, omitting directors' reports and cash flow statements.

Currently the information small businesses must file is limited to an abbreviated balance sheet with notes and a special auditor's report.

A further reduction in the quantity of information could lead trade creditors to become yet more cautious when extending small businesses' credit.

As official information diminishes, resellers' willingness and ability to produce up-to-date management data for trade suppliers becomes ever more important.

The current scarcity of credit insurance in the SME sector changes this from important to vital. The problems that the credit insurance industry faces are well documented.

Many insurers have reduced their exposure in what is seen as a high-risk environment, while distributors must make their own judgements and take risks to increase margins.

Good relationships between suppliers and resellers are crucial; distributors are more likely to extend credit for resellers if they are supplied with up-to-date information on which to base their risk-assessment decisions.

When a supplier grants credit it is making an investment in a customer, so it needs to understand the level of risk involved.

Hard facts such as financial statements are key, but industry position and management competence are also considered.

Nearly all suppliers will use credit reference agencies, so resellers should consider providing those agencies with the information the suppliers require.

This will help the agencies to review their recommendations, which are ultimately used by suppliers as part of their assessment procedures.

As publicly filed financial statements become more abbreviated, the transparency of a company's financial situation will become more difficult to ascertain.

The level of risk for those supplying credit will increase, bad debts will rise and a higher failure rate among resellers is likely, unless suppliers are kept informed.

Alan Norton is head of intelligence at credit reference agency Graydon.