Official government statistics from January 2021 showed £23.4 billion worth of late invoices owed to firms across Britain

Late payments can be a matter of life and death for small businesses. This fact was cruelly hammered home when Carillion collapsed in 2018, owing 30,000 smaller companies money and ultimately causing a 20% spike in insolvencies in the construction sector and the other small service firms caught up in the ripple effect. The same could easily happen again,  which is just one reason why prompt action is needed.

The matter of how and when large organisations pay smaller companies is a social and ethical issue, as well as an economic one. It comes down to how larger, more powerful businesses treat smaller, comparatively powerless firms, sole-traders and freelancers. If payments are made on time and not on extended payment terms of 60, 90 or even 120 days, the owners of a business can usually manage their cash flow to keep going. But if not, their future survival is rendered less certain.

Liz Barclay, Small Business Commissioner, said: “Solving the problem can’t be left to smaller businesses, who fear damaging the business relationship and not getting any future work if they dispute the payment practices of a bigger customer. They won’t bite the hand that feeds them. They need to have confidence that payments will be made promptly and fairly. Giving them that assurance requires the will to improve processes and understand the needs of small suppliers better. Firms need to know who they’re working with and to value their skills, services, products and expertise.

“We also need some changes in how we approach the governance of payment practices. They need to be much higher up companies’ agendas. If the way a company pays small suppliers was measured as a way of meeting social and governance ESG (Environmental, Social, and Governance) obligations for example we could see a cultural shift. There is a long road ahead, which is why it’s important to understand the complexity of the elements that make up ‘late’ payments, and what their root causes are and work towards fixing them.”

The payment problem

Late payments are a particular issue in the UK. Research conducted by the Federation of Small Businesses in 2016 found that 30% of all payments to SMEs are late, with the average value of each late payment standing at £6,142 and 37% of SMEs reporting that late payments cause cash flow issues. If late payments were halted, 50,000 businesses might have been prevented from going into liquidation in 2014 alone.

Unfortunately, the late payment problem has intensified during the pandemic, with unpaid B2B invoices increasing by 23% in the UK and Direct Debit cancellations reaching 40% in some sectors. A June 2020 study from the Federation of Small Business found that 62% of small businesses had faced late or frozen payments during the Covid-19 pandemic. Official government statistics from January 2021 also showed that £23.4 billion worth of late invoices was owed to firms across Britain, warning that this tardiness is a drain on businesses’ cash flow that threatens their “ultimate survival”.

This is not just an inconvenience, but a drain on productivity and a threat to the future of small businesses. McKinsey has estimated that the 5.5 million micro-businesses in the UK spend up to 74% of their time on activities that do not generate revenue – which could include chasing invoices. These companies have already done the work, but are being forced to put in unnecessary and unproductive hours in order to get paid, wasting time on paperwork that could be spent focusing on growth.

Medium to large companies can cope with late payments, but too many delays can prove expensive or even fatal for smaller businesses. When an invoice isn’t paid on time, freelancers or company owners often resort to borrowing money on their credit card or another consumer lending service, rather than turning to invoice factoring or other business-focused lending products with better rates. Three-quarters of Britain’s self-employed workforce – or three million people – use personal bank accounts for all business transactions, according to research from Quickbooks. This means freelancers and sole traders lose 15 days of paid work a year because they spend two hours every week laboriously processing company expenses from their personal bank accounts.

Liz Barclay said: “Borrowing is not always in the DNA of a small business, so owners use whatever alternative option is close to hand if payments aren’t coming in when they’re expected to arrive.”

This is not only expensive but could cause problems with friends and family. A poll conducted by IPSOS Mori on behalf of EY found that 39% of small businesses applied for overdrafts compared to 44% who chose to use credit cards – the most expensive form of lending. The same survey also found that 36% of micro-businesses use personal sources for loans or turn to family and friends, potentially creating friction between business owners and the people they love the most.

Solving a big problem for small businesses 

“One possible solution to the payments problem could be embedding the issue within corporate ESG,” Barclay added. “Today, it is unlikely that boards and chairs know much about their company’s payment practices. This needs to change. By making payments a governance issue, organisations can begin to tackle the problem and make life better for smaller suppliers.”

Voluntary codes are part of the solution. In January 2021, the government updated the Prompt Payment Code (PPC) to “crack down on delayed invoices owed to small businesses”. More than 3,300 companies have signed this code, which obliges them to pay small businesses (with fewer than 50 employees) within 30 days, half the time period outlined in the previous code.

The success of the PPC shows that positive outcomes can be achieved. Yet we can go further. Companies already publish metrics relating to their ESG performance, and there are rules that mean that bigger firms must report their payment times.

Investors and even potential employees could use such reporting data as a way to judge how ethical a company is, because if it doesn’t pay small suppliers on time then it may not treat its staff very well. Payment practice could become a valuable measure of culture and ethics in a company, enhancing the reputation of companies that act fairly and punishing those who don’t, without requiring legislation. A voluntary agreement or code creates an expectation among investors, who could come to demand action on late payments and therefore subtly push companies to take action. If investors demand prompt payments, companies are likely to respond.

There are also technological solutions. Larger businesses could offer automated, anonymised appeal systems, for instance. These would change the slightly awkward nature of asking for money and chasing unpaid invoices, as well as freeing owners from the fear that launching an appeal will sour the relationship and lead to less work in the future.

Mark Hartley, Founder & CEO of the business banking technology platform BankiFi recently spoke at an Open Banking Excellence Campfire and argued that there are already technological options that could help to solve the problem of late payments.

“Getting the invoice out there is not a problem – it is getting the person who receives the invoice to actually pay you that can be an issue,” he said. “This is where tech can help, by joining up payments and reconciling accounts with accountancy software and automating routine processes.

“Invoices can be sent automatically, with the payment that is made being automatically matched and reconciled with your accountancy package when it hits your account. Then, if the payment is late the software can send out a reminder.

“There are great solutions out there that not only solve the late payment problem but help businesses reduce the overall costs by removing the need for expensive accountants to do manual bookkeeping.

“By automating the process of invoice to pay, people that run businesses also get their time back in the evenings and weekends rather than spending hours on admin.”

Ultimately, solving the decades long issue of late payments requires a change in attitude that can be achieved with carrots, rather than just sticks. One day, I hope that companies will expect that graduates will reach the “any questions for us” stage at the end of their first job interview and ask: “What are your payment practices? Do you pay on time?”

We have already seen this happen with environmental and social issues. It’s beyond time for the same to happen with late payments.