Late Payers: Go With The Flow

If the cash flow dries up, your business can go under, so anyone who offers a way to help you cope with those late payers is worth listening to. Richard Nockolds reports

Brian Burke knows a thing or two about the financial health of the channel. He is the manager of the computer sector intelligence unit at Graydon, a specialist player in the credit information market. Graydon supplies the majority of the sector?s manufacturers and distributors with information about the viability of businesses operating in the channel.

Apart from the rather alarming fact that Graydon?s data suggests that something like one in five of the 30,000 businesses operating in the UK IT sector is unprofitable, the most critical area of concern in the sector is cash management. It would appear that the cliche ?turnover is vanity, profit is sanity, cash is reality? has particular resonance in the world of IT.

?The key thing,? according to Burke, ?is for a company to have the ability to control its cash flow. It?s not a question of whether it?s positive or negative. It?s control that matters.?

Controlling cash flow can be eased when trade credit isn?t an issue. Unfortunately, as Berkeley-based consultancy Global Touch found out, most channel players ?do not have adequate credit to fund day-to-day sales, let alone working capital requirements?. This was one of the main messages put across by Global Touch at its European conferences last year.

So, with cash and credit under pressure, where is the release valve? Assuming that the business is essentially profitable, then working capital, that soft centre of the balance sheet, is where the answer lies.

Working capital is the combination of current assets and their near-cousins, current liabilities. For anyone operating in the channel, this boils down to four basic elements ? inventory, trade debtors, short-term borrowings and trade creditors. The utopian equation of cash management is simply to turn inventory and debtors into cash quickly enough to pay off creditors and hence avoid costly borrowings. The reality, of course, is rather different.

Bank borrowing in the form of overdraft facilities used to be the principal source of funding for smaller businesses in the UK. Now, according to David Storey, a professor at Warwick University?s centre for small and medium sized enterprises, ?term loans have overtaken overdrafts as the banks preferred method for supporting small businesses?.

The problem with longer term loans is that they are usually secured by a fixed and floating charge over the borrower?s fixed assets. Sadly, since most resellers don?t have or need to have sizeable fixed assets, there is little chance that the UK?s unimaginative banks will find it easy to offer unsecured loans to a sector they find difficult to fathom. So cash management must focus on minimising inventory and debtors.

Inventory in the channel ain?t what it used to be, according to Burke. He says ?most channel players have got to the point where they buy on a back-to-back basis?. There is, in his opinion, ?very little stock within the channel. It?s only the real big boys who hold stock.?

The problem with stock is twofold. First, it?s dead money ? it?s lying there earning nothing or minus nothing until it?s sold. Second, thanks to pricing pressures and the velocity of new product launches, stock can be over-valued or near-obsolete in no time.

Also, when you have to compete with the likes of Dell, which was recently reported in Business Week as holding total inventories approximating to a laughably minuscule 13 days of sales, it?s easy to appreciate why most companies in the sector are inventory-averse.

So what about debtors? Here?s a topic on which there is no end of advice, even from the government.

Over the past 18 months or so, late payment has been one of the areas which has received some attention from Richard Page, the minister for small business. While the government decided ?not to introduce legislation to provide for interest on overdue commercial invoices? last summer, an information pack called Make the Cash Flow was produced in partnership with the Institute of Credit Management. The belief presumably being that Darwinian self-sufficiency was more viable than a legislative crutch. This pack is available free from the DTI, and it does offer practical advice on cash collection processes.

Another government initiative has been the introduction of a British Standard ? BS7890 ? for achieving good payment performance in commercial transactions.

Quite which companies are likely to tie this standard to their mast remains an unknown, but the committee which gave birth to this administrative gem includes more worthy institutions and trade bodies than you could shake a stick at, so it must be good, eh?

Thankfully, the business of collecting cash from debtors is one area where there is not just advice ? factoring, invoice discounting and leasing can offer useful help in accelerating payment from customers.

Diane Blinkhorn, marketing services manager at Lloyds Bank factoring subsidiary Alex Lawrie, says that factoring and invoice discounting are very similar, the only difference being that ?with invoice discounting the reseller is responsible for collecting the cash, whereas with factoring, the factor collects the cash direct from the end user?. In both cases, Alex Lawrie gives up to 85 per cent of the invoice amount to the reseller within 24 hours of receiving their copy of the invoice, the balance being paid as and when the end user pays up.

Alex Lawrie makes two types of charge for this service. First, it charges for the ?cost of money, very much like an overdraft?, at up to three per cent above Lloyds Bank base rate. It also charges a service fee, which for invoice discounting ranges from 0.1 to one per cent of turnover, depending on the size of the business. For factoring, this fee ranges from 0.5 to three per cent, although the average is 1.2 per cent. Blinkhorn describes Alex Lawrie?s services as akin to ?outsourcing a part of the accounts department to credit management experts?.

While Alex Lawrie is one of the biggest players in UK factoring, along with Lombard Nat West Commercial Services, International Factors (another Lloyds Bank subsidiary) and Griffin Credit Services (part of the Midland Bank), Kellock (part of the Bank of Scotland group) has specialised to some degree in the IT market.

Ben Allen, managing director of Kellock says that factoring and invoice discounting appeal differently to different types of company. ?Typically,? says Allen, ?smaller companies are interested in full factoring, whereas larger companies progress on to invoice discounting?. The average turnover for a company using Kellock?s factoring service is #1.3 million, and for invoice discounting it is about #11 million.

The one disadvantage of factoring is that the factors are not comfortable with services, bespoke software, and the like. They prefer to deal with hardware, consumables and shrink-wrapped software.

Leasing is slowly making inroads in the PC market. It still has a long way to go to reach the levels experienced in the mid-range and mainframe markets, and in office equipment such as copiers and franking machines. Apart from making the product easier to sell, the attractions of leasing are the speed with which you can get paid, and the fact that the lessor takes on the credit risk.

David Roberts, national development manager at Schroder Leasing explains how it works. ?First of all we get a customer proposal so that we can credit check the end user. About 90 per cent of the time this takes just four hours. Then, when we get a signed lease agreement from the end user and an invoice from the reseller, we can pay the reseller straight away. Depending on the value of the transaction that can be by Bacs, which takes about three days to clear, or by Chaps which is virtually instantaneous.?

Other leasing companies which operate in a similar manner include Anglo Group, First National Leasing, GE Capital Pallas and Lloyds Bowmaker Business Technology Finance.

Other sources of help in the channel have been around for some time, but they have yet to generate the same scale of success that they have achieved in the USA.

Deutsche Financial Services (DFS) was called ITT Commercial Finance until about two years ago when it was acquired by Deutsche Bank. Phil Underhill, regional vice president, says that specialised distribution finance companies like DFS ?provide the funding to carry a product along the full supply chain cycle, from manufacturer to end user?. This is done via three main services ? inventory financing, accounts receivable financing and asset-based revolving loans, which Underhill describes as a device where ?inventory and accounts receivables can work together to form the basis for a revolving line of credit?.

Transamerica Commercial Services (TCS) claims to be the market leader in providing what it calls ?creative channel financing? within the European computer industry. Miles Jaekel, business development manager at TCS, offers a service which starts with the manufacturer or the distributor. He says that ?resellers who apply and are credit approved by the finance company are given credit terms which closely match their cash cycle as well as an extra credit line facility which will be in addition to their distributors? terms?. Jaekel contends that ?resellers benefit from extra working capital at a competitive interest rate, credit lines are managed more effectively, cash flow improves, and working capital is released back into the business?.

Some distributors have packaged a range of financial services sourced from the likes of TCS, Lombard and others, which they pass on to their dealers. Distributors that don?t overtly package these types of service seem to prefer to work on a ?by exception? basis.

Ed Pacey, credit manager at Ideal Hardware, looks at specific deals, offering, where appropriate, something which suits both Ideal and the reseller. For example, if additional credit is required for a particularly sizeable transaction, Pacey might offer to invoice the end user direct.

Alternatively, he might set up an escrow account. This is where the end user pays for the products and services into an escrow account ? a transparent account with a third-party bank. The bank retains the cash until the transaction is consummated, and then pays the dealer and the distributor. Pacey may even offer a short- term ballooning of the reseller?s credit limit to cover a specific transaction.

It seems quite clear that there are a wide range of financial options available to those resellers that need additional support to bolster cash or credit deficiencies. But, as a Global Touch report, European IT Channel Finance: Today?s Changing Landscape, explains, these options are no cure-all for what is a fundamental weakness in the basic economics of the channel. The report concludes with two interesting caveats. It says that ?new financing options will not necessarily make strong partners? out of those resellers which aren?t either inherently credit-worthy or commercially astute. It also says that ?independent financing does not come free?.

There are inevitably some costs to be borne by someone in the chain. But who will that someone be?