Late payment of invoices is a concern raised mainly by small businesses supplying larger ones, as their invoices are consumed into an Accounts Payable process with many stages, inevitably leading to delay as the buyer uses trade credit as an alternative to interest-bearing credit.
Trade credit and financial credit can both be subject to late payment, but enforceable compensation clauses kick in when financial credit is paid late, whereas it is extremely difficult to request compensation for late trade payments and retain a positive buyer-supplier relationship – and it is even more difficult to enforce such compensation.
These problems arise where trade is being conducted on open account and with a credit period, and the supplier has no Letter of Credit, accepted Bill of Exchange or Bank Payment Obligation to ensure payment on due date.
There are structures that a supplier can enter into – at a cost – to ensure early payment, but each has its drawbacks:
- Offering an Early Payment Discount: this could be 2-5% of the face value of the supply and can work out to be a high cost if it is expressed as an annual rate of interest;
- Entering into an arrangement to discount all invoices where the buyer becomes aware of the sale and pays the invoice discounter: again the discount can be high and there is a potential reputation issue as buyers often associate these arrangements with suppliers that have weak financials;
- Factoring, which is the same as the preceding one but is not disclosed to the buyer, in exchange for which the discount is even a little higher;
- A Supply Chain Management offering put in place by the buyer itself, whereby a bank buys the invoices for cash and maintains the credit period to the buyer. These can be attractive, but a supplier to multiple buyers might then have to adapt to using a different system per buyer.
Absent these pre-configured structures, the seller will need to fall back on the basics:
- Have a written agreement with the buyer as to what the credit period will be and when it is measured from (date on invoice, sending date of invoice, receipt date of invoice...);
- Send invoices promptly when supplies are made, and confirm the date on which the credit period begins to the buyer for each invoice, thereby confirming the due date;
- Re-state the relevant dates and the credit period on each invoice;
- Maintain a relationship with the buyer so as to confirm receipt of goods/services and of the invoice, to ascertain if the invoice has become stuck within the buyer's approval process and why, to take the actions needed to make it unstuck, and to ensure that the invoice is lodged as "Payable", and is then proceeded to the list of invoices "Due and Payable" when it reaches the end of its credit period.
If the invoice is not paid, at least the seller has a paper trail showing that the buyer received the supply, found it satisfactory, should have paid but then has not paid. Were the seller to be holding an accepted Bill of Exchange, this paper trail would be unnecessary as the Bill counts as a "liquidated" debt - an irrevocable and unconditional undertaking to pay.
The invoice and the accompanying paper trail represent an "unliquidated" debt, and the pathway, time and cost to convert them into a "liquidated" debt differ from country to country, and sometimes depend on the amount: in the UK, small claims can be handled remotely through a central Small Claims Court. The buyer has, however, the right to object to the claim and then the matter may have to be pursued in front of a County Court.
Getting the judgement is one thing; then there is the matter of enforcement, and a legal process for that with further administration, time and cost – and remedies for the buyer to further delay the process.
E-Commerce has led to more business models where payment is by card, pre-shipment, so that the risk transfers to the buyer. In Business-to-Business commerce, however, open account with a credit period is equally common and then the risk is all on the seller.
Clarity of contracting is vital, meaning the paper trail before and after shipment. If shipment is domestic, there is no reason why the agreed credit period should not be adhered to by the buyer. With the rise of instant payment systems the buyer can wait until the last day of the period before initiating payment: there is no need to initiate a credit transfer two or three days before, and there is no need to make a cheque run.
Having said that, a cheque in the hands of the seller confers on them some of the same rights as an accepted Bill of Exchange, so payment by instant credit transfer solves one timing issue for the seller (e.g. the cost of money being in transit) but not the bigger risk issues (e.g. until the cash is received, the seller still has a weak legal position).
If shipment is to another country, one should factor in that all the financial processes take 50% or more longer. The seller's legal position is even weaker as they would have to act through an unfamiliar legal system. The seller's response should be to raise the invoice price by both the extra financing cost and the higher degree of risk, if the market will hold it.
Late payment under open account trade is not a problem that is going to go away. Codes of Practice have been proposed and even implemented, but the ethical buyers – who would have paid on due date anyway – abide by them and the late payers do not. A comprehensive legal change to make delay interest into an automatic right for the seller has been mooted, but could be frustrated by:
- Protection only being available to suppliers in the same country as the buyer;
- Late payers manipulating the process so that they do not accept that the agreed credit period has even begun, let alone finished.
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