The Economics of Debt

Any small businessman will tell you that debt is a huge burden. It is not only that the interest cost is a drain on money that can otherwise be invested but it is the notion that once you have a debt, it is damn difficult to get rid of it.

Other businessmen think debt is fantastic. From it you can leverage huge profits and it is the principle behind many private equity fuelled buy outs. For a small capital outlay, vast sums of money can be borrowed to buy companies which can be later sold with a disproportionate amount of profit from the risk going to the private equity house. In the purchase of Boots, private equity outlayed less than a few hundred million while raising £9bn.

Debt, in that sense is good. Philip Green used a pile of debt to pay himself a one-off dividend of £1bn tax free. Debt, in plenty of senses then, is good.

But for the average business, the problem with debt is that it has to be productive in terms of increasing profits. Without a huge boost to profits, cashflow does not sustain the interest payments and so you have to borrow more in the hope that your business will catch up. In the end, it can be good money after bad as the implosion inevitably comes as the debt gets ahead of the business. For small businesses, debt is only good for working capital and generating more cash, beyond that it is a millstone.

So how do Government's view all this? The US just closed out its fiscal year with $1.4 trillion of debt, the highest national debt since 1945. As former Head of the Fed, Alan Greenspan, observed this is the most worrying aspect of the US economy. The equations start getting explosive in his eyes as more money is required to pay interest on the debt and you end up borrowing more just to pay the interest - the priority has to be to bring that debt down.

There are a few ways to do this. First up, you can get the economy growing, which is why there is so much debt there at the moment as the US tries to use more debt to stimulate the economy. This is exactly Greenspan's issue - using debt to stimulate growth can go horribly wrong and it's exactly what small businesses fear - if the revenue streams do not come through fast enough to bring much needed cash, then pretty soon you end up borrowing more. The second way, is to sell assets which has been the recent domain of the UK Government. The problem is that beyond gold, countries usually do not have easily 'liquifiable' assets. In Britain's case, we no longer have large golden stakes in large companies, we have the stakes in the banks but they are all still under water while other things like buildings and debts are not so easily sold. One thing we did not have was gold to sell. Such asset sales, as a small businessman would know, tend not to add much to the coffers to reduce debt - in our case it may be a few company cars, maybe a building, furniture or plant facilities. Asset sales of this type are usually done in desperation, like pawning jewellery in the face of credit card debt. Inevitably you are a buyer's dream and so you will never get full value for your assets as the British Government will soon find out.

Further, selling assets as a business means you have less to bargain with for the future and for a Government, once it is sold that's it - gone. The final way to make inroads into debt is to make cuts in the budget. Small businesses know all about this. Wastage is the first port of call but usually there is not a massive amount of 'wiggle room'. Certainly, the end of month pizzas may go, fresh flowers in reception, travel is fairly game forcing salespeople and managers to think hard before travelling and then looking levels of spend on things like flights and hotels. Then it gets nasty - the biggest expense for small business is the salary bill and that's where cutting can produce real savings. Of course, you are affecting your future capabilities but needs as must - for my money, it should always be the last port of call.

And so to Government. I argued yesterday that cuts can be made very easily - when you look around at the multifarious layers of Government and the associated lackies and cost, long before you start affecting public-facing services, you have vast layers of expense which are pure wastage. This is an easy starting point for Government and savings can be realised very quickly by canning external advisers, consultants, halting project overruns, getting rid of contractors, looking at layers of management and getting rid of many of them.

It has been pointed out that this recession has been felt almost exclusively in the private sector and that the public sector has done nothing to rein in cost, eliminate wastage or make cuts. Thus, the majority of the newly unemployed have come from the private sector. Yesterday, we saw positive results on the unemployment number as the rate of additions to the total seemed to slow and this had a small positive effect on the budget deficit forecast for the month. This could be a false dawn as the Government are going to have to start making some serious cuts - very soon and that means people hitting the dole queues from the public sector. It's crazy that it hasn't yet happened - but it has to.

My point in all this is that as small business people we know the economics of debt. It is a bad thing, particularly when markets are depressed. You can borrow in such times but it is usually out of desperation when in all reality, you should be cutting your cloth. Spending money in the hope things will come good, without a great plan for finding ways to grow, usually ends in tears as interest payments mount.

Alan Greenspan knows a thing or two about economics and I think he is right. Debt is know reaching the critical point - Britain is spending in the hope of an upturn and spending big. While you have to spend money to stimulate, you have to realise that in the background you have to make essential cuts.

It isn't as if we cannot survive if cuts are made - Britain is a bureaucratic monster with one of the heaviest public sectors in Europe. If we cannot find efficiencies in this structure then we ought not to be in Government, because as small businessmen we can see it all too easily.

The public sector is too big, too fat, has overly generous pension schemes and is a huge burden on our taxes and business - it has grown vast, inefficient, multi-level departments, which are mini-governments in themselves, over the last 12 years that has spawned regulation after regulation culminating in the last tranche of the farcical new Companies Act just last month which was years in the making, issued in 3 almighty sections and added really just 4 things of note to over 97% of the number of companies in Britain.

The waste is just awesome and shameful - and it needs to be cut, and fast.

Show Me The Money

All small businesses are exposed to the risk of slow or even no payments from clients. When you are a service business like mine, very often it is prudent to insist on upfront charges or faster payment. But sometimes, no matter what the contract says, if a large client pays late, there is little you can do but grin and bear it.

The inequity of the system is brutal as very often the very client who withholds money on you, is a company who has a cash business at the front end.

Large Companies Can Be The Biggest Sinners

I recently highlighted the problem showed in the Panorma Show where Boots plc had unilaterally, without warning, changed the payment terms for its suppliers.

I have experienced the same but without the courtesy of a letter - it just happened.

For most small businesses, while it would be great to actually slap a writ on a client, in practice it is not possible to get too heavy. A large client is, after all, providing a source of revenue and profit. However, this month things changed for me, when my largest current customer held payment on invoices dating back to before Christmas and has paid only the smallest invoices as a show of good faith which merely covered expenses not fees since. Having crossed the boundary of VAT due dates, I have now paid all the VAT on those invoices and without any cash in, so salary costs to my contractors and myself have been delayed.

However unacceptable I may think this is, and there have been plenty of urgent communications to get this sorted out, in reality I cannot get too angry and throw my toys out of the pram as they have shown in the past that they eventually pay, their credit rating is good and they are one of the lucky companies who are enjoying growth in recessionary times. It is the sort of client I can ill-afford to be without.

I suppose I should just thank the Lord my business is not dependent on the Public Sector who, despite the rhetoric of Mr. Brown, are the worst payers in business by a long chalk.

The Prompt Payment Code

The new Prompt Payment Code (PPC) was devised in and introduced in December last year. Any company can sign up to it and it is purely voluntary with no recourse in law - usual rules apply. Signatories sign up undertake to:

1. Pay Suppliers on time - within agreed terms at the outset of the contract, without attempting to change payment terms retrospectively and without changing practice or 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 agreed terms.
3. Encourage good practice - by requesting that lead suppliers encourage adoption of the code throughout their own supply chains.

The PPC is being monitored by a festoon of organisations like the Institute of Credit Management, the Federation of Small Businesses and the Forum of Private Business. Sadly, none of these organisations have any real teeth and none have good membership from larger companies. The trouble often with such initiatives is that they look good on paper but because you do not have to buy in and cooperation of large businesses or Government Departments, then it is likely to fall by the wayside.

Our Worst Nightmare

I have been doing a lot of business in Italy of late and the one thing that strikes you is how businesses survive over there. Credit terms are generally understood to be 60 days at the very minimum but are often at least 90 days and more like 120 days and yet more with Government Departments regularly taking 6-9 months to pay bills. This, of course, has a massive ripple effect as it cascades through the supply chain. You might think that correspondingly prices are higher in Italy to compensate for this but the reality is the opposite - if anything, competition is more keen.

For companies entering the Italian market, if at all possible, do so via a partnership or Distribution and just make sure they are financially solid enough to manage your market on your behalf, even if that costs some extra discount as is likely.

Britain, in my opinion, is fast becoming the same way. Large firms are using suppliers as a source of credit as banks are not so easy with their money any more.

Spin And Guff

Professor Nick Wilson of Credit Management Research Centre at Leeds University believes the PPC is just PR spin both from the Government and the signatories and it has all been seen before. There have been similar attempts at codes in the past but Government did not get behind it and impose its rules - Government even withdrew funding for the Better Payment Practice Group which really said it all.

Wilson agrees with me - in his opinion, the situation has worsened considerably for smaller businesses over the last 10 years.

Your Rights

In 1998, the Late Payment of Commercial Debts (Interest) Act gave small businesses a statutory right to interest on money owed to them by large companies or the public sector and to claim debt recovery costs. However, it is a case of cutting off your nose to spite your face as few companies resort to the law for fear of losing their clients' business.

It is a real Catch 22 situation.

Naturally, when the rights were extended to big businesses, they had no problems enforcing it. For many smaller businesses, it means they are getting squeezed at both ends - larger suppliers giving them aggressive payment terms which they are penalised heavily for if they transgress while large companies refuse to hold to their payment terms who are their customers.

Also, a case in question is VAT payments. In the case when a large customer has not paid on time and you cross a VAT quarterly boundary, and if a large supplier has held off paying for 60 to 90 days, you can end up paying all the VAT without money coming in. The Government sees only you and not your customer, who they are happy in the same quarter to reimburse the exact same VAT you have charged them.

The system is a complete mess and penalises the company that has not been paid.

In reality, there is little that can be done about the situation. SMEs are right in the middle and we make up over 90% of the volume of companies in this country and account for 13m employees yet we have a minor say in how the process should run and no voice when it comes to large company customers and Government not paying.

Companies Signing The PPC

Notable companies like Asda, British Gas and John Lewis have signed the PPC code had little to say when contacted on the subject and this bears out Wilson's PR spin accusation. It's all for show. Asda, for one, has actually implemented some good schemes to help. They have won awards for their supplier schemes and 'Where's My Invoice?' is one which allows suppliers to go online and track their invoice through the Asda payment system to be able to tackle issues which may delay payment as and when they occur not when the money is overdue.

Real Experiences

The large customer I refer to has not signed the PPC and is not interested in doing so. Just this morning in answer to my latest protestations, an accounts clerk has asked me to send a Statement of Account, then having denied receiving it despite a read-alert warning telling me they had not only received it but read it, they then claimed they had not received any of the invoices despite me having read-receipts for them all.

Of course, calling them liars does not help the situation and may well jeopardise future business, but I don't think this is at all unusual for small businesses. We are at the mercy of the system and until Government actually puts their money where their mouth is on this issue like cleaning up the VAT payment scams, then we will always be at the bottom of the food chain.

I hope Lord Mandelson gets to read my blog - his ears should be burning at least!

Crunching on Credit

Tonight's Panorama program entitled 'Credit Where It's Due', which features a documentary by Theo Paphitis of Dragon's Den fame, looks at some of the experiences of Britain's 4.5 million small companies who provide some 13 million jobs in the credit crisis.

It should be interesting viewing and I am sure we all have our stories to tell. On the program will be comments from Lord Mandelson and there will be some shining examples of how banks and large companies take out their woes on small businesses.

Big Company Syndrome

One example was particularly appalling - a small dental supplies company in Herefordshire was unilaterally sent a notice by Boots plc, one of its customers, telling it without notice, reason or discussion that they were moving their maximum payment terms from 30 to 75 days. It means, as we all know, that using end of month 'supplier payment runs' Boots can extend terms to beyond 100 days. In this particular example, Boots not only paid after 75 days but took a 2.5% discount for doing so without negotiation or notice - no doubt assumed to be a 'prompt payment' discount. In any other circumstance such un-agreed terms could be breach of contract at minimum or, in terms of the discount taken, even theft. But as the small business is dependent on Boots for a major line of business, it just has to sit there and take it. The example was not exaggerated as Boots admits on the program that it is 'reviewing its terms' and does not deny doing this.

Morals, Ethics and The Law

I believe what Boots did was immoral, bad ethics and downright illegal and an abuse of its position as a large customer to many small firms dependent on its distribution skills. No one denies them the right to want to change terms, but there should be discussion and agreement involved beforehand at minimum.

We have a local chemist acquired by Boots - it will be the last time I use it.

For many of us in small business this is not at all unusual. While we try and pay our own suppliers as well as we can because failure to do so will effect our credit terms and therefore ability to run our cashflow and expand, our large customers can easily dictate and change terms which are not agreeable to us with impunity from the Law. It is a case of, 'If you don't like it, I will go elsewhere'.

Currently, of my own 5 contracted customers, one of them pays beyond the terms and because it is currently my largest customer, despite discussions and some warnings, they have ignored the contract they have signed and take terms of up to 60 days when my services are given up front. My cashflow is suffering heavily despite buoyant billings and at this stage it means late salary payments at least. In normal circumstances, when contracts are relatively easy to find, I would refuse to do further business with them. However, I do not have that luxury and the people I do the work for remain embarrassed and highly professional - and I enjoy working with them. It is the Finance Department that dictates the rules.

Banks and Their Role

I generally do not have any real issues with my bank. I run my accounts in credit and the only issues I have at times is that I sometimes do not transfer funds into my credit account ahead of big payments from my deposit account and so go into the red momentarily. As I use Internet Banking, this is usually never more than 24 hours and I do get charged but it is rare it happens anyway. However, at one point I had bought one of their high interest bonds with a six month, fixed interest term, which enabled me to park the money I owed in Corporation Tax and make it work for me. For just a week or so only, due to payment timings, I needed cash for salaries at the end of the year which were important to trigger tax refunds.

Would they lend me it? No. Not even the fact that I had held in a Bond in their bank over 5 times the amount of money I required for just a single week, they said they never lent money to fund salaries. In fact, they actually then told me that the terms of my overdraft were more then they should be and reduced it.

As you will see in the Panorama program, the risk of talking to the bank as a prudent measure on funding, can actually work against small businesses, as it can trigger newer, more stringent terms that they are trying to apply. By meeting or talking to you, they can claim to have had the discussion and so implement new terms which, once again, as we are dependent on their good will for our own enterprises means that we have no choice but to comply.

What Were The Bail Outs For?

I come back to the senseless, ill-planned and badly implemented bank bail outs and Government Schemes. Firstly, the bank bail outs have singularly failed in their supposed purpose in helping small businesses and house owners get credit. What has happened is that money has been quickly gobbled up to pay for continued lifestyles for the rich executives, 'wealth creators' and 'rainmakers' who got us into this mess in the first place. Secondly, the banks have used the bail outs to largely save their investment and other banking businesses - their consumer and small business divisions which typically trade profitably have been used as a source of funding to prop up these horribly failed areas. As always, banks look after these stupid executives who run their businesses on 'boom and bust' cycles and know nothing about creating and managing sustainable, steady businesses. That's why they then raid their stable, profitable businesses for cash and fire rafts of the staff in order to cover for their own failure.

In the end, small businesses and consumers pay the price of failure.

So to The Government

Lord Mandelson is a two-time failure in morals so there is no reason to suspect that he or any of the Treasury goons who came up with the bail out and Government Schemes had a shred of compassion for small business. In fact, Lord Mandelson seems only interested in those businesses whose proprietors are fabuslously wealthy which should tell us a thing or two about his morals. The priority was on sustaining the engine of the banking system, those on the edge had to fend for themselves. So there was none of that money that came with the non-negotiable stick that said X% of it goes into INCREASING loans and credit to small businesses. We hear again over the weekend that two banks have defied the Government to pay £2bn in bonuses to staff.

To put that into perspective, those banks will pay in bonus alone nearly double the amount of money allocated under Mandelson's Enterprise Finance Guarantee Scheme. It is abundantly clear where the priority lies.

Further, in some fit of bravado, the Government promised that not only would their departments pay on time, they would pay in 10 days. I can assure you that businesses who depend on Government custom are NOT receiving payments on any invoices in 10 days. It's why most small businesses shy away from doing business with Government as we become small scale banks for them - how fitting then that Mandelson's quote on Panorama tonight will be that 'The Government is not a bank.'

I come back to a central point in my blog of late and don't apologise for it. The Government, in tackling this fiasco, has surrounded itself by advisers from the world of investment banking. This has meant that the very people who failed to spot and gauge the disaster are telling us how to spend vast sums of money in order to get us out of it.

Like the Government, they are proving to know as much about the solution as the cause, and we should not have been surprised.

But what is more shocking and disgusting, is that from the start they have prioritised the saving of their own particular part of the banking industry and system at the cost of the core of banking business and the industries and consumers who depend on them.

And we have paid for it and will continue to do so for years to come.