It's an entrenched part of UK corporate culture, but late payment is gambling with the future of small businesses. Will a new voluntary code of practice shame the culprits or is it simply PR spin?

When it comes to the burning issue of late payment, the worst offenders are big businesses but the hardest hit are small firms. And the effects can be far-reaching: a strain on cashflow, staff lay-offs and, worst of all, companies going bust. Last November, the Institute of Directors (IoD) conducted a survey among members to determine the extent to which late payment had grown compared to the previous year. Of the 1,036 respondents, 18 per cent said it was becoming "very much more of an issue", 35 per cent thought "somewhat more" and 43 per cent "about the same".

"Some of our clients are paying us later and later," says Suzanne Richmond, office manager of west London-based RD Property Maintenance, which specialises in domestic and commercial property maintenance and insurance works. "Things got so bad with one of our major clients that we had to issue a statutory demand for payment. That was about five months ago, and we still haven't had all the £100,000 that they owe us. When we get money in dribs and drabs it affects our cashflow, so we have to pay our creditors later, too. We've also had to lay people off. That affects our reputation, which is important to us in being able to attract more work."

The scourge of late payment covers "a multitude of sins," says Alexander Ehmann, head of parliamentary and regulatory affairs at the IoD. The most obvious one is just paying later than the specified terms, with no discussion, explanation or negotiation. Another is changing the payment terms—from 30 days to 90 days, for example—midway through a contract. In other situations, companies with terms of, say, 90 days, but whose practice has been to pay within 30 days, are changing their deadlines to 90 days and imposing settlement discounts for earlier payment.

"Such practices may not be illegal, but they are certainly unethical and probably immoral, too, given the damaging effect on small businesses, for whom certainty about when they will be paid is paramount," explains Ehmann.

The government has been one of the worst offenders. So small business organisations welcomed Gordon Brown's statement in the House of Commons last October that it would "aim to make SME payments within 10 days". A spokesperson for BERR says Whitehall is already delivering on its commitment. "We recently examined payment data from 10 government departments and found that 88 per cent of payments were being made within 10 days, with six per cent being paid in 11 to 20 days and six per cent within 21 to 30 days," she claims. The government recently extended the requirement to pay within 10 days from Whitehall departments to local authorities.

Some are sceptical about these claims. "We do work for the NHS and they certainly don't pay us within 10 days—it's usually much longer than that," says Richmond at RD Property Maintenance.

But Philip King, director general of the Institute of Credit Management (ICM), says what is important is the intent to pay promptly. "If the government is paying within 30 days, that is a huge improvement on where they were a year ago," he says, pointing out how much effort needs to be invested in changing a system that was predicated on far lengthier payment terms. "You can't effect that kind of change overnight," he argues.

Now that the government has started to put its own house in order, and encouraged banks to play their part by agreeing to a stronger code of practice governing their dealings with small companies, it is turning its attention to the role that big businesses should play. The most recent manifestation of that is the new Prompt Payment Code, launched in December (see below).

Any company can sign up to the code, which is being managed and monitored by the ICM through membership organisations such as the IoD, the Federation of Small Businesses (FSB) and the Forum of Private Business (FPB). But to be accepted as a signatory, companies need two referees that will testify to their good payment practice, and they have to renew their application every six months. Suppliers or potential suppliers can see which of their existing or prospective customers have signed up, and can lodge a complaint through the site if one of the signatories has reneged on their commitment. An independent panel drawn from ICM membership will examine complaints and take them up with the companies in question if they feel they are legitimate. The company must address the issue if it is to continue being a signatory.

"We don't intend to dramatically name and shame transgressors, but just removing their name from the site will attract publicity," says King. "We don't want to put companies off signing up, because the point of all this is to demonstrate leadership and spread good practice. Nearly every company will have a county court judgement against it for some reason so it is unrealistic to expect that things will never go wrong. You can never be sure why buyers aren't paying on time; it may even be the suppliers' own fault." King hopes that by the middle of this month at least 1,000 companies will have signed up-including most of the FTSE-100. "We need to get to that critical mass quickly in order to get the momentum essential to culture and practice change," he says.

But Professor Nick Wilson, director of the Credit Management Research Centre (CMRC) at Leeds University Business School, is sceptical. "It sounds like PR spin—from both the government and the signatories," he says. "I've seen it all before. We've had a similar code in the past, but the government never even tried to enforce it. Also, it withdrew funding for the Better Payment Practice Group, which played a useful role in spreading good practice and highlighting examples of bad practice." The CMRC has surveyed payment policy and practice by listed companies for over 10 years, and publishes the results on its website. Over the decade "the situation has worsened for smaller companies," says Wilson.

In 1998, the Late Payment of Commercial Debts (Interest) Act gave small businesses a statutory right to interest on money owed them by large companies or the public sector, and to claim debt recovery costs. Small firms rarely resorted to the law for fear customers would stop buying from them. As Ehmann puts it: "The one thing worse than being paid late is not being paid at all."

But when the right to charge interest was extended to big businesses,  they had no such scruples in taking advantage of it. "We have big suppliers and they are getting tighter on their payment terms," says Richmond. "If we don't pay promptly we get legal letters. So we are being squeezed in the middle."

Wilson adds: "The legislation hasn't worked, because it hasn't tackled the problem of the relative bargaining power of big and small companies." He believes the solution to the problem would be to enforce the Companies Act. All public companies are obliged to include a statement on their payment policy and practice in their annual reports, but Wilson's research shows that just 4,000 out of the UK's 10,000 public companies (many of them subsidiaries of PLCs) comply with this requirement.

Companies House should not accept reports that don't contain information on payment practice, says Wilson, adding that auditors shouldn't sign them off, a view shared by King, Stephen Alambritis, head of public affairs at the FSB, and FPB chief executive Phil Orford.
But Clive Lewis, head of SME issues at the Institute of Chartered
Accountants in England and Wales, argues that chasing up companies is not the role of Companies House. What's more, he adds, other than pointing out to directors that they have omitted a statement on pay, "auditors' powers are limited".

Other than bland statements about why the Prompt Payment Code is "a good thing", signatories contacted by Director, including Asda, the John Lewis Partnership and British Gas, had little or nothing to say—a coyness that seems to bear out Wilson's charge of PR spin, and that appears to fly in the face of one of the three key conditions of being a signatory—to proselytise good practice.

"We signed this code because it is the right thing to do," says Bernard Hughes, Asda's head of government relations. "I won't be proselytising among my peers, but we will work with the government to do the right thing. We are in this together."

Asda, says Hughes, launched two initiatives in 2008, which led BERR to select it as an "exemplar". Where's My Invoice?, a free online service, allows suppliers to track where payments are in the system and amend issues that could cause delays, such as incorrect details. Pay Me Early is an optional facility that enables suppliers to request a one-off early payment, at a discount, should the need arise. "We aim to pay every supplier on time every time," says Hughes.

The phrase "on time" can mean many different things, of course. But it is early days and, as with the government's efforts to get its house in order, the statement of intent implicit in signing up to the new code is an important first step by companies. But the code will be no silver bullet, particularly as late payment is so deep-seated in UK corporate culture. Alambritis sees it as "one of a basket of measures" to encourage better practice. But perhaps the most important of those steps, and the one small businesses have most control over, is ensuring that they set up contracts correctly, agree sensible payment terms, invoice promptly and accurately, and chase up overdue payments in a professional and timely way.

"The mistake many small firms make is to assume they will be paid on time, whatever that means," says King, who helped write a series of 10 guides on managing cashflow, which are available on various websites, including those of BERR and the ICM. The guides cover issues such as payment terms, invoicing, chasing payment and knowing your customer, and aim to foster good practice.

RD Property Maintenance is looking to appoint a debt collection agency, but, says Richmond, it has also learned "not to give bigger credit limits to customers than we feel comfortable with". She adds: "Another lesson is that there is no such thing as a 'safe' customer—however big and blue-chip they are. We are much clearer in setting out the rules at the beginning, and if companies are not prepared to abide by the rules, we consider whether we want to do business with them. In the past we were prepared to take a nip in our margin to do business with some blue-chip companies, because it was our bread and butter, but if they are not paying on time, what's the point?"

But Darren Pearson, managing director of Exposure 4, a video production company based in west London, asks: "Just how many small companies are in a position to choose which customers and clients they work for?" His business has not been badly hit by late settlement, he says, because it has a system of staged payments, starting with a 50 per cent deposit from a customer upfront, followed by one or two payments at stages in the development of a video, and then a final sum when the work is completed.

"The arrangement benefits both sides," says Pearson. "It allows smaller companies to budget and bigger companies to plan. We do the work more quickly, and they get their goods more promptly."

The FPB's Orford believes that small companies should have more confidence in dealing with big customers. "Lots of them are vital members of the supply chain, and if they understood what power they had, they might be more ready to dictate payment terms, withhold supply or charge interest on late payments," he says.

Indeed, if more small firms became smarter at managing suppliers and started to flex their muscles, it could do more to bring their big customers to heel than any law or voluntary code could ever do.

Follow the code...
Three steps to faster payment

The Prompt Payment Code was launched by the government at the end of last year. Signatories must undertake to:

1 Pay suppliers on time within the terms agreed at the outset of the contract, without attempting to change payment terms retrospectively and without changing practice on length of payment for smaller companies on unreasonable grounds.

2 Give clear guidance to suppliers by providing them with clear and easily accessible guidance on payment procedures and ensuring there is a system for dealing with complaints and disputes, which is communicated to suppliers. Suppliers must be advised promptly if there is any reason why an invoice will not be paid within the agreed terms.

3 Encourage good practice by requesting that lead suppliers encourage adoption of the code throughout their own supply chains.