Insight - Get me to the bank on time

Most financial directors know that the new law on statutory interest for late payments takes effect on 1 November, but many believe that it will not affect them much. After all, for the first two years only small businesses will be able to claim interest on late payments, and it is generally expected that most of them will not do so. (A small business is defined as one having fewer than 50 employees.) Fear of upsetting their customers will see to that.

However, there are some nasty surprises in store further down the line.

Statutory interest does not have to be demanded when payment is received.

It can be done at any time until it becomes statute barred, six years for England and Wales and five years for Scotland.

So it does not follow that because a supplier is happy (or perhaps frightened) now, the same will be the case in six years. When a customer stops ordering, a supplier has a strong incentive to demand interest back. And liquidators and receivers have the same rights and are certain to use them when recovering debts. Indeed in some cases, unclaimed statutory interest will be a company’s biggest asset. Potential payments will sometimes be so high that they will have to be disclosed in the published accounts as a contingent liability.

Take a company that regularly makes purchases worth #100,000 a month from one small supplier. Payment terms have never been agreed, even though the supplier asks for 20 days from invoice date. The company actually pays 60 days from the end of the month in which the invoice is raised.

Nothing happens until, in December 2004, the company receives a demand for #135,000 statutory interest – a sum it would have to pay.

If you have nerves of steel you can check the calculation. The interest rate for late payments is base plus 8%, so an average of 15% over the period might be a reasonable assumption. The new act calls for payment 30 days after invoice date (in most cases), unless a different period has been agreed. So payments have been made an average of 45 days late.

If interest rates go higher, the demand will be more, possibly much more.

To protect their companies, financial directors will need to agree mutually acceptable terms and then stick to them. It sounds too good to be true and it probably is, but this is exactly the object of the legislation and most of us will be delighted if it happens. The risk is that the big and the powerful will use their muscle to make the small and the weak sign up to a long credit period. If this happens, payment will be no quicker than before but the delay will be legitimised.

The other side of the coin is that financial directors will want to keep open their option of claiming statutory interest for themselves and will want to resist formally accepting long payment periods. It is in the interest of sellers to leave them unagreed, even if payments are arriving late.

They will need to keep very good records of money received. An action relating to a six-year-old payment will only succeed if adequate six-year-old records are available to support it.

All this is in the future because the Act applies only to contracts signed after 1 November. From that date on, small businesses will be able to make claims against large organisations and the public sector. In two years, small businesses will be able to claim against other small businesses.

Two years after that, all organisations will be covered by the Act.

Make no mistake, the effects of the new law will be far reaching – 8% over base rate is high enough to hurt any company. It is a severe sanction and it will be used to devastating effect. Most of us know at least one businessman or woman who feels that they have been unfairly treated by a customer, and we will have heard them say that they wish they could do something to the “late-paying bandits”. Soon they will be able to.

And if late payment puts them out of business, they will be able to reach out from beyond the grave and, through the receiver, hit their enemies where it hurts.

Roger Mason is a former finance director who writes on business matters and presents seminars.

LATE PAYMENT: VIEWS LARGE AND SMALL

Jeremy Lee, FD with Tepnel Life Sciences, an R&D company specialising in DNA detection instruments

(Turnover of #0.13m to 30 June 1998)

Small companies like ourselves will probably not use the new act. Trading is all about building relationships. Using a “whip” on customers is not the right way to meet objectives. The Act could be used by organisations that operate in a monopolistic environment, but we would be scared of losing existing clients.

It could lead to a change in the terms and conditions of trade. Rather than agreeing to pay in 30 days, clients may ask for a 60-day period to avoid paying interest.

David Defty, FD with the retailer Sears

(Turnover of #1.8bn to 31 January 1998)

I fully support any initiative that ensures traders follow their contractual terms of trade. The most important thing for any small trader is cashflow.

But, while a penal interest rate on overdue accounts is certainly helpful, it does not actually solve the original problem of late payment of debts.

Therefore, in addition to the imposition of an interest rate, any attempt to streamline the debt recovery process and in particular the court system would also be a great help to the small trader.

Robert Steele, FD with the accounting software vendors Exchequer Software

(Turnover of #3m to 31 December 1997)

For the first two years, the new law can only be used against large companies with over 50 full-time employees and the public sector. This means small companies need to keep files on the staff levels that its clients have.

The records will need frequent updating and could be time consuming to set up.

A company will also need to implement a system to calculate the interest.

But there should be little need to resort to charging interest if an accounting system has sufficient credit control functions in place.

Dennis Robinson, director of operations with retailer C&A

(Turnover: unpublished)

The act is good for business generally. Late payment is particularly a problem for small businesses and this will help them. Businesses rely on their income costs and late payment effects profitability and competitiveness.

The costs of late payment can be passed on, usually to the customer, but with negative effects.

The new law will help the situation, but initially small companies need to collectively decide that they will all take action against larger companies.

The act also needs an effective court system to back it up and make the claim process easier.

Interviews by Sarah Pennacchia.