One bad debt by a large customer can damage the cash flow of many small and medium-sized enterprises (SMEs), and even lead to insolvency. And for manufacturing and logistics companies in the Middle East and North Africa (MENA), slower global economic growth, high energy prices, inflation, and soaring interest rates have made delayed payments or non-payment for goods and services more likely.
Is your industry at risk of delayed payments and defaults?
A high number of logistics companies in MENA have experienced late payments and bad debt over this year. Trade forwarding companies transporting goods domestically and internationally have been particularly at risk due to the poor performance of some of their end partners. Unlike cargo companies, which refuse to release goods until payment is received, freight forwarders deliver goods quickly and are not usually in possession of those goods when payment is due. As such, they have very little leverage, if a customer defaults.
Manufacturers of metal, auto parts, and chemicals in the region have also experienced these issues, especially those exporting to more challenging markets. In the crowded IT space, some companies have increased their bad debt risk after entering riskier markets, in order to increase their sales figures. Additionally, in the construction industry, contractors are reporting an upsurge in late payments.
What happens when customers fail to pay?
A company can face the following risks if a customer pays late or a debt is ultimately deemed unrecoverable.
- Cash flow issues
Late payments can result in a company not having enough cash to fund its immediate operational costs, such as wages. A logistics company, for example, may be unable to fund transportation expenses and fulfil existing contracts. For a manufacturing company, interrupted cash flow could hinder its ability to buy an adequate supply of raw materials that could lead to production delays. Late payments can also tie up working capital that could otherwise be invested in growth — such as the purchase of additional vehicles or machinery, for instance. If a large customer defaults, the slim margins that many companies are operating on at present may put them at risk of becoming insolvent.
- Increased borrowing costs
Companies facing losses can request a bank facility to help bridge the gap. However, given the high interest rates at present — most central banks in the region have mirrored the rate increases of the US Federal Reserve — these will boost operating costs significantly.
- Debt recovery and legal expenses
Companies may have to resort to legal action or use debt collection agencies in an attempt to recover outstanding amounts. These processes are almost always costly and time-consuming, and divert resources from the company’s core business operations. However, there are steps a company can take to avoid the risk of late payments and defaults.
Three steps to mitigate late- and non-payment risk
The impacts of bad debts and late payments can be far-reaching, but there are a number of strategies logistics and manufacturing companies can implement to reduce the risk of late-payments and defaults.
- Customer screening and selection: First, the company should choose the right customer at the outset in order to avert bad debt. Companies can check the financial health of a prospective customer by reviewing their financial statements, requesting references, purchasing business information on them, and where practical, carrying out a field visit to check their premises and staff.
- Efficient debt collection processes: Streamlined debt collection procedures with well-timed pre-legal and legal steps to carry out in the instance of a delayed payment will help a company collect overdue revenues. If attempts to recover debts internally are unsuccessful, a company can consider using a debt recovery service.
- Trade credit insurance: Trade credit insurance will indemnify a company in the event of payment delay or insolvency of a customer insured under the policy. There are other benefits of a trade credit insurance policy. They can facilitate a company’s expansion into untested markets, improve access to capital, and increase sales with existing customers. The benefits of this type of insurance that go way beyond bad debt protection will be outlined in the next instalment of this series.
For more information on reducing your exposure to bad debt or late payment risk, please contact your Marsh adviser.