Management and finances

Avoiding default: How to protect your liquidity

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When your key business partners suddenly stop paying their bills, this can jeopardize the liquidity of your own company. We have some tips on how you can prevent defaults and hedge large financial risks so that larger invoices don’t cause you to lose sleep.

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    Meine Firma

    Original text published in “Meine Firma” (My Company), the SME magazine of AXA Switzerland. "Meine Firma" is published in German, French and Italian.

    TO THE CURRENT EDITION

No one likes talking about unpaid bills. And no one wants to put their business partners in a tight spot. Even if most invoices are paid on time, SMEs also see bills going unpaid. You are constantly at risk of not being paid for goods that have already been delivered or services that have already been rendered. And this risk has only increased due to the economic difficulties of the the past two to three years. 

We’ve talked to the experts and some companies so we can show you how they mitigate default risks and how you can set up an efficient receivables management system.

Risky leveraging: from default to bankruptcy

Customers that don't pay can quickly put start-ups and SMEs in a tricky situation. But when is an account considered in default?

What is default?

Default is when an agreed payment is not paid, and due to the insolvency of the debtor, it can no longer be collected.

Paolo Larentis, Head of Sales of Credit & Surety at AXA knows only too well: “In economically uncertain times in particular, the insolvency of your most important customer can also have far-reaching consequences for your business. Every third bankruptcy is due to a domino effect.”

Suppliers and customers are third-class creditors under the law, and as such have to wait in line when it comes to entitlement to a company's bankruptcy assets. The claims of employees and the OASI are ranked higher, for example. The horrible part is the enormous leveraging effect: With an assumed net margin of ten percent, ten times more profit must be made in order to offset solely the loss arising from the defaulted payment. If you have to shoulder CHF 10,000 in lost profit, then you need to make CHF 100,000 more in sales to offset this loss. And of course here, too, there is the risk of default.

5 measures against default

This makes it all the more important to prevent delinquency early so it won’t escalate into a risky situation. You can take the five steps below to protect your company from default:

  1. Written documentation
    Always keep a written record of all your business transactions. If there is any doubt, you will then have highly detailed information about the product that was delivered or the service that was rendered.
  2. Make immediate payments attractive
    Try to increase your percentage of immediate payments. You can do this mainly by offering payment options or discounts for immediate payments.
  3. Review your customers’ credit and payment history
    Check your customers’ credit before you sign a contract with them (or have it checked). Set up customer profiles that include entries for payment history. This lets you take quick, decisive, and – most importantly – targeted measures when problems arise.
  4. Set up receivables management
    Create a structured dunning system. Don't shy away from taking a customer to court as your last step.
  5. Let go of customers who make no improvement
    Do not hesitate to let go of a customer if they repeatedly fail to pay their bills or take a very long time to pay them. 
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    We review and monitor the credit situation of your customer base worldwide and warn you in good time if one of your client’s credit ratings is deteriorating.

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Receivables management: What should I do if a payment is late?

If a client does not pay their bill, you should take immediate action. The quicker you react, the more likely you are to get paid. Here’s what your receivables management could look like:

  1. Payment reminder: Make a friendly request or send a payment reminder. Base your tone on how you normally communicate with this client. Maybe give them a call? This makes the connection more personal and it’s really quick.
  2. Dunning process: If following up and sending reminders yield no results, then the next step is to send a debt collection letter (don’t forget to add on the fee for this). Depending on how long you want to or can afford to wait and how close your ties are to the client, you can send one or two debt collection letters. One typical and effective measure to use in the debt collection process is to stop delivery of goods or services until you receive the outstanding payment.

When should I send a debt collection letter?

Regardless of whether you're dealing with a private person or a company, from a purely legal standpoint, you only have to send debt collection letters to customers if there is no concrete payment date on the invoice, but rather a time limit (e.g. “within 30 days from receipt of the invoice”). If a specific deadline is given (e.g. “Payment due by 02/26/23”), then the person or business is in default after this date even without a debt collection letter. In order to keep up good customer relations, we would suggest you send a reminder letter even in this case instead of resorting directly to debt collection measures. Incidentally, a 30-day payment deadline is not prescribed by law. You can also set a deadline of ten days, for example. If your company has enough liquidity to manage, you can also set yourself apart from your competitors by setting a longer deadline.

If you have sent the customer (several) letters but have not yet been paid, there are two more options left: 

3. a) Debt collection: You can take your case to the debt collection office in order to initiate proceedings against the debtor. If the outstanding invoices are not paid after a payment summons has been sent or no objection has been filed, then you can take legal steps: An arbitration process and/or court proceedings will be initiated. 

Note: If the delinquent person or company is located outside of Switzerland, then court proceedings can be more complicated because they will be held at the foreign court that has jurisdiction. In this case, you should definitely seek legal advice right away in order to avoid extensive fees.

3. b) Debt collection proceedings: You hire a debt collection agency to collect on the debt for you. They will start debt collection proceedings against the delinquent person or company. If this does not resolve the issue, then they will take legal steps after consulting with you. The only difference between this situation and Step 3a is that here you are outsourcing the process to an external service provider.

Tip: Make sure to clearly define the payment date in any letters you send so there can be no room for misinterpretation.

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How can I secure my liquidity as a start-up or SME?

Companies seeking not just to lower their risks, but also not to bear any risks at all can purchase insurance or use factoring. Business owners can sleep well at night knowing they have this added level of security, which is all the more important during times of crises. Here are two options you can use to keep your company safe from defaults:

Trade credit insurance – maximum protection against defaults

If you want to secure all your unpaid invoices rather than just individual invoices, then trade credit insurance is a good option for you. It is especially worthwhile if many of your clients are located (further) abroad or they have subsidiaries based there.

Another advantage is higher credit ratings

Companies that have secured their outstanding receivables through an insurance policy are rated higher. This generally garners you more attractive conditions on loans.

Some of the benefits of trade credit insurance are:

  • Guaranteed indemnification for delinquent payments by the invoice deadline
  • Settlement of receivables management
  • Credit checks for new clients and credit monitoring of existing customers

Factoring – conveniently delegate your receivables management

Factoring is ideal if you don’t want to mess with collecting unpaid bills. You can outsource this task to a factoring company that will immediately pay the amount owed you (generally with a 10% deduction), in return for a fee for their services. The factoring company then takes over the debt collection process with the end client.

Note: Some companies may require you to repay the amount they paid you if they are not able to collect the debt. For this reason, you should check the terms of the agreement before choosing a factoring company.

Factoring makes the most sense if your clients are in good financial standing, your company is financially healthy and you are interested in outsourcing this administrative task.

Trade credit insurance or factoring – which one is right for my company?

The best way for your company to avoid delinquent debt depends on various factors. Our overview gives you the relevant aspects.

The most important differences between trade credit insurance and factoring are in regard to who can use the solution, what is to be paid, what is secured, when the payment needs to be received and what company this solution is suited to.

Hedge the risk for delinquent payments

Companies are becoming less and less inclined to bear the risk for delinquent debts themselves. Nor are they interested in doing the work involved in checking credit ratings and managing receivables. Two AXA clients tell us how insurance has helped them in concrete terms in their day-to-day business.

No worrying about unpaid invoices, no hassling with debt collection

“In the past two years, we’ve had many more customers who lack the liquidity to pay their bills,” relates Pascal Fellay, CFO of Cremo SA. The second-largest milk processing company in Switzerland supplies retailers as well as hotels and restaurants.

Cremo SA has had a trade credit policy for over 20 years. The policy takes over debt collection when the invoice remains unpaid after the due date. The insurance courteously asks the client to pay the outstanding invoice. If necessary, it will then begin debt collection proceedings. If the proceedings go forward, the insurance will represent the legal interests of the company. Pascal Fellay is pleased with this service, “For us, it is a very practical solution because we can just hand over the entire case.” 

The company decides at what point debt collection should be brought against the delinquent client. If non-payment is unavoidable, then AXA trade credit insurance will cover the unpaid invoice. “It is not possible for us to take on this risk. If a key partner takes bankruptcy, it could jeopardize our company,” states the CFO.

In the past two years, we’ve had significantly more customers who lack the liquidity to pay their bills.

Pascal Fellay, CFO Cremo SA

Cremo SA

The second-largest milk processing company in Switzerland processes milk from western Switzerland and the canton of Bern to make products such as butter, cheese, cream, yogurt or milk powder. Headquartered in Villars-sur-Glâne, the company has some 800 employees and has been a stock corporation since 1927, but is not publicly listed.

cremo.ch

Maintaining an overview of your main clients’ solvency

Not only does trade credit insurance come into play when difficulties are first encountered. It also has a preventive effect. The insurance company continually monitors the credit rating of the customer base, which saves companies a lot of time. “If AXA lowers the credit rating of a company, this serves as a warning for us and we can take appropriate action. If it raises the credit rating, then this gives us peace of mind, so we can sleep soundly at night,” explains Pascal Fellay.

Roland Schwyter, Backoffice Head at PVA AG agrees. The company sells flooring, doors and wood-based products and has also had a trade credit policy for some time. “We learn early on if one of our business partners is having financial difficulties. This has helped us out quite often.” The volume of their clients exceeds their ability to keep an overview, which is why the service is especially valuable for them. “Without trade credit insurance, the cost of our receivables management would be considerably higher,” says Roland Schwyter.

PVA AG has seen some surprising defaults, notes Roland Schwyter, Backoffice Head.

Despite credit monitoring, PVA AG has seen some defaults, notes Roland Schwyter. Once a carpenter who had always paid his bills suddenly went under. “That was a complete surprise that came without warning.” Thanks to trade credit insurance, PVA AG came out fine. “We are lucky to have a lot of reliable customers. But as everywhere, there are exceptions.” For that reason, it is not possible for them to take on this risk themselves. When building and renovating houses, they often have a great deal of capital tied up, which PVA AG is not willing or able to put at risk.

PVA AG

The family-owned company headquartered in Altendorf in the canton of Schwyz sells flooring, doors and wood-based products and supplies woodworking commercial businesses in the greater Zurich area, in central and eastern Switzerland as well as retailers throughout the country. Since it was founded in 1954, PVA AG has grown into an innovative SME, employing around 80 people together with its subsidiary GUIGNARD Parkett AG.

pva.ch

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