The impact on late payments could be enough to end a small business, so how can we make sure customers are paying on time?

This episode on the Payments Podcast is reviewing the real impact of late invoices, and how organisations can make it more worthwhile for their customers to pay on time. This episode also looks at the impact of technology on invoices, is there really a way of organisations getting paid on time, every time?



Rich Williams: Hello, and welcome to the ‘Payments Podcast’. Today, we're going to talk about a rather serious topic, one which is experienced by many businesses, and that is the late payment of invoices.

I'm your host, Rich Williams and I'm joined once again by my colleague, Marcus Hughes, head of strategic business development.

Marcus has a wealth of experience in working capital management and will share with us his advice on reducing the occurrence and impact of invoices being paid late. Welcome back, Marcus, and thank you for coming in to talk with us today. You're becoming a bit of a fan favourite on the show.

Marcus Hughes: Hello, Rich, thank you. It's good to be back again.

Rich Williams: So the late payment of invoices is definitely a growing concern, which is widely reported in the media and complained about in many forums as well. To reference some data, we compiled alongside Ipsos MORI in Bottomline’s annual business payments barometer. We saw that 92% of financial decision makers surveyed admitted they pay suppliers late.

Now, whether this is deliberate or not, that's alarmingly high and serves to highlight the scale of the problem. So what's going wrong, Marcus? And why is this such a widespread issue?

Marcus Hughes: I agree, the figure is worrying. And, unfortunately, the late payment of commercial invoices, especially invoices from small businesses is very common and in many other countries too, so not just the UK. But there are a range of technologies and good practices which businesses can apply for reducing the volume and the impact of late payments.

In that business payments barometer, a number of reasons were given by people who were surveyed to explain why their businesses make late payments to their suppliers. These were split between internal reasons and external reasons. Some of the internal reasons were excuses, like, “Our accounts payable processes hamper our ability to pay on time.”

That that was the most common explanation. Survey respondents also said, “We pay late to protect cashflow or prioritise other payments.” Another reason for paying late is, “To avoid using our overdraft facility and reduce borrowing costs.” So turning to the external reasons for paying invoices late, the highest response was, “The quality of the goods or services was not as expected. So we withheld payment.”

Another reason was incorrect details on invoices. And finally, for me, probably the most baffling of reasons was that the supplier did not chase payment of their unpaid invoices. Some of these explanations are probably more justifiable than others, especially in a supposedly collaborative business relationship between buyers and their suppliers.

Continue Listening: The Digital Expectations of Getting Paid 

Rich Williams: Thanks Marcus. Now, hasn't the government been trying to improve the situation? And in relation to that, can you tell us what's been happening on the regulatory front to address the issue of late payments?

Marcus Hughes: Yes, certainly. For many years, governments and trade associations have been trying to help small and medium sized businesses to get paid sooner, but with only limited success.

In recent years, there have been several major government initiatives to reduce late payments. That's not just in the UK, but also across Europe. Back in 2013, the European Union introduced a directive on combating late payment in commercial transactions. This directive laid down maximum commercial payment terms.

So it's 30 calendar days from invoice receipts for public sector payers and it's 60 calendar days from invoice receipt for private sector payers and all invoices must be settled within 30 days, if no period is actually specified on the invoice.

So according to the directive and to protect suppliers, if payment terms are not respected, creditors can charge penalty interest at base rate, plus 8% per annum, as well as a fixed fee of €40. So extensions can be agreed between counter parties, but only if these new terms are not grossly unfair to the creditor – that's the party getting paid – and provided these extensions are in line with good commercial practice.

This definition of good commercial practice usually involves making a comparison with the business's peer group. So you can determine normal payment terms for that particular industry. In the UK, that EU directive was implemented through the late payment of commercial debt regulations, and that was also in 2013. So theoretically, the EU directive and the UK regulations give small and medium sized businesses, more power to act.

That's all very nice in theory, but you have to admit it's highly questionable whether in practice, a small business would risk a valued business relationship by charging an important customer penalty interest on invoices that are paid late. You think that might be a pretty effective way to upset your customer and make them think again on whether they buying more goods or services from you. So this new regulation creates quite a dilemma for businesses.

More recently, the UK’s prompt payment code demonstrated good intentions to go one step further than the late payment regulations. This voluntary programme encourages businesses, not just to obey the law, but to actively make prompt payments closer to 30 days instead of the 60 days allowed by the regulation.

The thousands of businesses that have signed up to this code have undertaken to pay invoices within a maximum of 60 days, and to seek to pay within 30 days as the norm and avoid practices that are grossly unfair and adversely affect their suppliers. As there was not much sign of improvement, another legal requirement was introduced by the UK Government in April 2017.

This was the duty to report on payment practices and performance. This major requirement affects all companies with a turnover of more than £36m or a balance sheet total of more than £18m or more than 250 employees. So it's a lot of organisations and it includes UK subsidiaries of foreign parent companies.

Every six months, all these businesses must publish information on not only their normal payment terms, but also the actual performance against these normal terms. This requirement includes the need to report a whole range of statistics, such as the maximum payment term agreed with suppliers. The average time taken to pay invoices. The proportion of total invoices paid beyond agreed terms. The percentage of total invoices paid in three timeframes. That's 30 days or less, between 31 to 60 days, and beyond 61 days.

Businesses must also report on the amount of late payment interest owed and paid to their suppliers and dispute resolutions processes have to be explained. Also, businesses have to report whether they've put in place e-invoicing, supply chain finance, or preferred supplier lists.

So all these duty to report requirements affect many organisations in the UK, and it can be absolutely fascinating if you like that sort of thing, to check up on the performance report of your own customers and suppliers. These are all publicly available on a very useful government website.

Rich Williams: Thanks, Marcus. I won't need to point out to anyone listening there that there's clearly a plethora of requirements and measures to ensure that late payments are avoided. Now, maybe I'm answering my own question there, but it begs the question, why is it so hard for businesses to actually comply with the payment terms laid down in what you've just mentioned?

Marcus Hughes: There are a whole range of problems and reasons, some of which have already been mentioned regarding inefficient processes and the lack of invoice automation within businesses. But there's another fundamental reason regarding this widespread business practice of paying invoices late. A big reason is that in every supply chain, there's a natural cashflow tension between the buyer and the supplier.

This is because most financial decision-makers apply well-established working capital guidelines. This means the business should manage its cashflow carefully and focus on getting paid as soon as possible. This is knowing as reducing a business's days sales outstanding. This business term is often abbreviated to DSO.

It's a measure of how long it takes a business to get paid for its invoices. Of course, reducing DSO greatly helps the business’s inbound cashflow, which is vital to any business's financial wellbeing. Cash is king, of course, as many treasury specialists are going to tell you and they recognise that good cash flow is the very lifeblood of a business, whatever industry or sector they might be operating in.

As well as working on reducing the day sales outstanding, that same business will follow yet another well-established and common sense good practice for working capital and management. This other important activity is to defer paying supply invoices as long as possible. This is known as extending your days payable outstanding, which is abbreviated to DPO. This means the timing difference between receiving supplier invoices and paying those invoices.

So it's clear that an extension of days payable outstanding also has a positive impact on a business's cashflow and avoids any additional borrowing, which might have been needed to be drawn down in order to make a payment to that supplier. Therefore, by deferring paying invoices, a business reduces overdraft costs and delays funds leaving the business's bank accounts.

So from the payer's perspective, this is good working capital management. So these two principles of reducing day sales outstanding and extending day payables outstanding are two sides of the same coin and are widely used in most businesses. The trouble is that typically a large buyer holds the balance of power here.

The big buyer literally has more weight in this logical cashflow tension with its suppliers, especially if these are small or medium sized suppliers. So suppliers can all too often find themselves waiting for settlement of their invoices with relatively little power to change the situation. But there are tools that can help.

Rich Williams: So on that point, then, could you describe please, the technologies and tools which can solve the situation or help to solve the situation and make it easier and more worthwhile to pay invoices sooner? So let's start with accounts payable.

Marcus Hughes: So let's begin with some operational and process changes that can be made. In the Bottomline business payments barometer survey, the biggest reason given by financial decision-makers for paying late was that, “Our accounts payable processes hamper our ability to pay on time.” At the root of this problem is the challenge that more than 70% of invoices globally are still a paper-based, that's according to the Billentis market report on e-invoicing.

This is a detailed and comprehensive report on e-invoicing and accounts payable automation. Historically, some large companies have relocated inbound invoice processing to low cost markets. For example, in Asia Pacific and in such regions, paper invoices are re-keyed into ERP systems more economically.

Although the benefits of labour arbitrage have helped cut costs in the short term, some of these programmes have already been hit by salary inflation and rapid staff turnover. Even worse, some accounts payable departments, STP actually means ‘straight to printer’ that's instead of STP’s proper meaning, meaning ‘straight through processing’.

This is because in some accounts payable departments, invoices received electronically are being printed, circulated as paper, approved, and then re-keyed, even though this all sounds completely counterintuitive. So I'd say it's high time for the next step in migration, from paper to electronic to take place.

It's now technology’s turn, ready to lend a hand, in removing this roadblock to efficiency. And there's a great deal a business can do to improve its purchase to pay processes, which places them in a much better position to pay invoices in a timely manner.

Rich Williams: So where a business does rely heavily on both paper and -e-invoices and in different formats, what can they do to manage that more effectively?

Marcus Hughes: Well, recognising that each business is at a different point along this migration to streamlined invoice automation, it's important that any comprehensive AP automation solution should handle both paper and electronic invoices and in a range of formats, so they can support customers wherever they are situated on that road toward straight through processing.

Under this pragmatic model, inbound paper invoices are scanned, validated, matched, and then routed electronically for approval in an efficient and timely way. And an important part of this process is data capture, which means extracting data from scanned images.

Optical character recognition technology can be used to extract this data from images of those invoices, even at a line item level. Meanwhile, any incoming invoices received in a variety of formats electronically, which could be PDFs, CSV flat files, XML, these can all be mapped into a suitable normalised electronic format of the invoice to suit the payer's invoice approval workflow or their ERP system.

So all incoming invoices should be compared to the pair’s business rules to ensure they are acceptable. For example, checking that they're addressed to the correct legal entity or that local VAT rules are satisfied. And if any invoice fails these basic tests, the supplier can quickly be advised of the reasons for rejection so they can resubmit.

By combining paper and electronic invoice processing in this way, an efficient invoice data capture capability can cut the cost of an AP department enormously with savings ranging from 50 to 80%.

Rich Williams: Wow. So what's the next step in the invoice automation process, please?

Marcus Hughes: So the next step in the processing is matching and validating invoices where data from paper and electronic invoices are automatically matched against purchase orders and goods received notes, according to predefined criteria.

Just like invoices, these POs and GRNs can also be received in paper or electronic formats. But by this stage, all invoices, POs, GRNs, etc., should be transformed into consistently formatted electronic data. This matching activity is very important in reducing fraud risk since this discipline shows the goods have been ordered and received.

Invoices can be coded at line item level, making it easy to split costs across multiple cost centres or cost codes. All quantities, calculations, and totals should be checked as a way to ensure the accuracy of any invoice data that's been captured. Fully compliant invoices can then be automatically approved for payment. Not all businesses like this hands-free approach, but by automating the straight through processing and approval of validated invoices, AP staff can be freed up to concentrate more on managing other exceptions and so on.

So a file of matched invoices and a file of non-matched invoices can typically be uploaded into a corporate ERP or invoice management system within a couple of days. That's as opposed to a delay of 10 to 15 days in an organisation which is still using manual processes.

Rich Williams: So a lot of what you described there seems to be heavily reliant on invoices, actually having purchase orders attached to them. And as we know, that's not always the case. That clearly is going to make the matching process described, impossible.

So what can be done where invoices don't have a PO number attached to them?

Marcus Hughes: Exactly. Yes, you're right. For invoices which don't have a purchase order, the next step is to apply the approval workflow. Authorised users with the necessary entitlements can access a web-based workflow to review and approve those invoices and manage the exceptions.

Identified anomalies are emailed to the relevant approver for resolution and the nominated approver can then forward, hold, reject or approve those invoices. So a browser-based workflow with email alerts and automated escalations built-in should ensure that anomalies are dealt with quickly and invoices do not get lost or delayed in approvers’ paper-in trays.

So accounts payable personnel have access to real-time reports on the status of invoices, down to an individual transaction level. And working with invoices is much easier after the invoice has been converted into an image and data. Online workflow enables rapid resolution or referral of queries and with full control and visibility at all times.

Alternatively, for those organisations who prefer to use their own ERP approval workflows, I think, files can then be uploaded to the corporates host system. However, in those organisations with multiple ERP systems, it's often easier to access via browser, an invoice management system positioned as a hub, which links these various ERPs.

This makes it much easier to perform the approval workflow in a standard way across the enterprise. This is more efficient than using a disparate collection of ERP platforms. So streamlining and automating the management of invoices can cut the average processing cost by over 50%. This approval workflow step… Sorry. After this approval workflow step, approved invoices can be uploaded to the corporate ERP for payment processing.

Rich Williams: And how would you sum up the operational benefits of accounts payable automation?

Marcus Hughes: From an operational point of view, to make invoice processing more efficient, solutions like scanning, optical character recognition – that's OCR – inbound e-invoicing, and cloud-based accounts payable approval workflow, all make it easier and faster to receive, validate and approve invoices.

The operational benefits of automation are lower processing costs as well as improved visibility and control. The migration from paper processing to managing electronic documents and data also reduces fraud risk and operational risk of paying those invoices twice.

And in the context of the problems which businesses experience in paying invoices on time, it's worth highlighting that AP automation makes it easier to comply with late payment regulations and show proper respect for suppliers by paying them according to payment terms. And it's not just accounts payable departments which gain. It's also very helpful to give your suppliers easy access to information on when and how they're going to be paid.

So using a supplier portal is a simple but effective way of making this information available to your suppliers on a self-service basis. As a logical enhancement of AP automation technology, a supplier portal is a secure platform where suppliers can submit their invoices electronically and check the status of their invoices and see when they're going to be paid.

And they can also generally download remittance information for easy reconciliation of inbound payments. But for me, more important than all of these operational benefits that we've been discussing, there are some highly valuable strategic benefits which can be delivered by improved invoice automation.

In particular, automation drives faster, cheaper, and more accurate invoice approval. So from a strategic point of view, the faster approval of invoices puts the buyer in a good position not only to pay invoices on time, but also to offer an early payment programme for selected suppliers.

This can be a highly collaborative way to strengthen a supply chain with benefits for both buyers and suppliers.

Rich Williams: So the benefits sound very useful in theory, but how would an early payment programme work in practice, Marcus?

Marcus Hughes: Okay. So, as soon as invoices are approved, the buyer gives the supplier the option to get paid early, minus a small interest charge or discount. This information and workflow to handle this process is made available to suppliers on a cloud-based supplier portal.

This can also be described as a supply chain finance portal. And this platform shows the supplier all invoices which have been approved by one or more of his big customers. And the supplier can see not only the normal invoice maturity date, but also how much interest charge will be deducted from the invoice’s face value to get one or more of those invoices paid early.

The supplier simply uses the platform workflow to click and select the approved invoices for which they want to get paid early. The funding for this early payment programme can either be from the buyer’s own surplus cash or external funding from one or more finance providers. At the invoice maturity, the buyer then settles the invoice by paying the full amount to the finance provider.

If the buyer uses its own funds to finance these early payments, then the buyer receives a share of the interest deducted from the payment, which has been made to the supplier. And it's the supplier at- Sorry, I should say, hence, the buyer gets a good return on its surplus cash without any risk because the buyer has already approved those invoices and received the goods.

So these early payment programmes are often called supply chain finance, which is a fast growing form of finance and is helping suppliers to get paid early. The interest rates applied are generally much lower than some other forms of finance used by suppliers, such as factoring or receivables purchase programmes.

Rich Williams: With those less familiar with supply chain finance solutions, who actually benefits the most from this? The buyer or the supplier?

Marcus Hughes: So, if well-structured, supply chain finance offers great incentives and benefits for both the buyer and a supplier.

The supplier improves cashflow by getting paid early at a rate of interest, which is generally better than they can achieve by their own direct bank borrowing. Meanwhile, the buyer can receive a revenue share from the finance provider, which effectively reduces the cost of goods that the buyer is actually purchasing.

So, alternatively, in some special cases, buyers can actually extend their payment terms further. This has a positive impact on that important working capital metric, which we mentioned earlier, days payable outstanding or DPO. But even in these situations of extended credit for the buyer, the supplier still gets paid early with the finance provider bridging this funding gap and earning interest for this early payment service.

So, what we achieve here is a win/win situation for the buyer and supplier. And arguably it's a win for the finance provider too, as they achieve a good return on a low risk asset, which is self-liquidating. This is because the buyer has already committed to pay the invoice at its maturity date. And there's a very low risk of non-payment as these kinds of facilities are generally only made available to corporates with good credit ratings.

Now, as we've seen, supply chain finance does have many positives, both for suppliers and buyers, but there have been a few isolated cases here in the UK and overseas when some of the credit terms being applied are particularly long and where almost all supplier invoices are being paid early, under supply chain finance programmes.

In a few extreme cases, this has led to doubts being raised by credit agencies when trying to assess the credit worthiness of big corporates on the basis that it's hard to get a clear view of the corporate's overall liabilities, which in turn raises question marks over whether these liabilities should be classified as trade creditors or bank borrowing.

So I would emphasise the need for such finance techniques to be used with balance and moderation, and also with proper accounting opinions, of course. So aside from that consideration, a number of finance providers have proposed supply chain finance as a practical solution for managing working capital more efficiently at the same time as complying with late payment of commercial debt regulations that we looked at earlier.

So buyers continue benefiting from extended payment terms while providing liquidity for suppliers at an early date and frequently at a rate of interest, more attractive than a smaller, medium sized business could normally achieve when using their traditional financing products.

Although supply chain finance is not specifically referenced as a solution within the EU directive, the UK Government has actually been, in the past, been quite supportive of the adoption of supply chain finance as a way of delivering liquidity to small and medium sized businesses.

Rich Williams: So aside from the efficiencies in the issuance and receipt of the invoice itself, is there a role here for faster payments in helping supplier invoices to actually be paid? So the mechanism to get funds over more quickly?

Marcus Hughes: So in recent years, there's been a significant increase in the use of faster payments. And this trend definitely looks set to continue. There are a number of use cases supporting this increase in faster payments. For example, customer refunds, online lender disbursements, settling insurance claims, and payroll for contractors. Looking ahead, I expect we're going to see more business to business payments traveling through the Faster Payment Service.

For example, this could be as an incentive for just-in-time supply chain management. This means your supplier holds your stock, but agrees to deliver it rapidly as soon as you need it. So that supplier might deserve an instant payment to compensate them for this rapid delivery service.

And another example might be paying a supplier immediately via faster payments if they want to get paid quickly under an early payment programme, which we've just discussed. That would be instead of waiting, say, three days for a BACS credit transfer. The fact that UK faster payments transaction limit is typically £250,000 for many reasonably sized and credit worthy businesses, this does open up the opportunity for greater use of faster payments for those business to business payments.

And it's worth noting that the UK Faster Payment Service and the Payment Systems Regulator are actually considering raising the limit of our faster payments to £20m, which would certainly encouraged plenty of B2B usage, I think.

Rich Williams: Marcus, thanks for sharing this advice on ways to get invoices paid more quickly with the introduction of new tools and technology in the accounts payable function of the business.

Now, let's switch tack slightly and look at what can be done from the opposite direction, namely accounts receivable. So what's their approach?

Marcus Hughes: The good news is that there's a whole series of very practical steps, which a business can take in order to reduce the likelihood of their customers making late payments and also to improve inbound cashflow.

So, as I mentioned earlier, cashflow is the lifeblood of any business, so much so that a high proportion of organisations, which fail, actually have inefficient management of their inbound cashflow as the main reason.

So, effective cashflow management is a mission critical task. So here are a few good practice tips on improving your chances of getting paid by your customers. First, you should simply check out your customers creditworthiness and reputation. At the start of any new business relationship, it's important to research your customer’s solvency.

So you need to check with credit agencies, the local chamber of commerce, and you should of course review your customer's financial accounts. And this is not just a one-off exercise. You've got to carry out periodic reviews and recognise that your customer's financial situation can change over time and that's for better or for worse, of course.

And it's also really important to make sure you clearly document your terms and conditions of trade. This includes stating and writing your delivery and payment conditions. You must always ensure that your invoices are complete and accurate. You can use technology to make sure your invoices contain all the necessary information for your customers so that they can fully understand what you're asking to be paid for, how and where to pay you in a timely manner.

Document management technology can be used to automate the consolidation of all this disparate data, drawn from a whole range of sources across multiple systems. This approach can also ensure that key information is highlighted and easily visible on your invoices. Any omissions or errors can simply give your customer an excuse to delay making payment to you.

So you need to include a load of important but obvious details; your company's name, address, telephone number and contact name. Your customer’s proper company name, address and contact person. The nature and quantity of your goods or services, your customer’s references such as their purchase order number/ Pricing in the appropriate currency, and very important, don't forget to specify the payment terms, which you've agreed upon in advance.

It sounds obvious, but don't forget to include your full bank account details so your customers know exactly where to pay you and when. This is basic but important stuff. Another important step is that you should distribute your sales invoices as soon as possible.

In accounts receivable, it’s vital to prepare and send out your invoices quickly and accurately as soon as your goods or services are delivered. For fast delivery of invoices to the right destination, you should be distributing your invoices electronically from a cloud based platform. These invoices can be sent as PDFs attached to emails or, better still, as machine-readable data files. Ideally for important customers, these data files should be tailored to the data preferences of those customers.

This makes it easier for your invoices to be absorbed into your customer’s systems with minimum problems, hence avoiding re-keying. Sending invoices electronically is not only faster and more reliable, it's also of course cheaper than using paper and postal services. Once you've distributed your invoices, you need to do everything you can to track whether your customers intend to pay your invoices in a timely manner.

One useful technique is to use a cloud based invoice distribution platform, which allows you to check whether or not your customers open and view and approve your electronic invoices. By identifying those customers who don't bother viewing invoices, you can focus your efforts on chasing those invoices, which are not yet being downloaded as these are the ones at highest risk of making a late payment.

And it's therefore important to contact these customers, to remind them that your invoice is soon due for payment and that it needs to be reviewed and approved in advance of the payment date. Some platforms allow an electronic dialogue between you and your customer. This makes it easier for them to raise any queries, to request additional information and, in general, to help the customer to approve the invoice more efficiently.

Likewise, you can check that your products were delivered in good order and in the correct quantities. This help you to prevent late payments if the customer's not satisfied. And if you go through this work early, there's still time to rectify issues before the invoice is due for payment.

The whole process can be presented as part of a good customer service, but actually it has the important benefit of improving the likelihood that your invoices will be paid in a timely manner.

Rich Williams: Are there any finance techniques that an AR team can implement to tackle the problem head on? So, earlier, you described the supply chain finance model, which is initiated by big buyers wanting to help their suppliers get paid more quickly. What can suppliers do for themselves to decrease that time to payment?

Marcus Hughes: Yes. There are several finance tools which can help here. One simple but effective technique is to offer your customers early payment discounts. This is an incentive to your customers for making timely payments. An early payment discount is when you offer your customers a small discount if they pay quickly. This early payment discount offer should be spelled out clearly in your written and agreed terms and conditions of trade.

And it must also be specified in writing on your invoices. The best known, fixed early payment discount rate is 2/10 net 30. This means that if a customer pays the invoice within 10 days, instead of at the end of the usual trade credit period of 30 days, then that customer or buyer can apply a discount of 2% flat on the face value of the invoices.

This is actually a big incentive to the buyer to pay early since a simple arithmetic shows that the equivalent annualised rate is 36% per annum. That's because the 2% discount is earned by paying the funds a mere 20 days early. So in fact, the annualised rate is over 43% when calculated as compound interest.

So it's a really, very significant discount. All these techniques and tips help a business to increase the likelihood of getting paid earlier and therefore reducing their days sales outstanding. As I've already mentioned, this is an important working capital technique since by accelerating inbound cashflow, a business reduces its dependence on external borrowing and increases its cash holdings.

So this, in turn, positions the business to invest in new stock with a view to getting into position to sell more products. So a virtuous circle.

Rich Williams: Is factoring another suitable financing tool for sales invoices?

Marcus Hughes: Yes. That's absolutely right, actually. So now let's look at a couple of external funding models, which a supplier can use to accelerate its inbound cashflow. Finance providers have developed a range of asset backed finance techniques. The two most widely used solutions are factoring and invoice discounting. Factoring is an important tool for accelerating cash flow from sales. Factoring companies actually provide a range of services of which finance is just one aspect, although it's a very important element of the factoring package.

So factoring services would usually include the outsourced management of the supplier’s entire sales ledger, credit assessment of the client’s customers, after which the factor establishes credit limits against these individual trade debtors.

Also, bad debt cover of approved trade debtor limits and collection of debts. So in factoring, the supplier’s receivables are legally assigned to the factor. This means the supplier is using its sales invoices as collateral or security to obtain finance. And when the sales invoices are sent customers, each invoice must specify that it's been assigned to the factor and that the supplier's customer must make payment direct to that factor.

So in this way, that factor is in direct contact with the buyer, that's the trade debtor, and has expertise in a comprehensive range of procedures for collecting debts, such as issuing reminders, chasers, and having established processes and experience in legal proceedings to pursue debtors in case of need.

Factors usually make prepayments of up to 80% of invoices covered by approved trade debtor credit limits. On the invoice maturity date, the buyer pays the factor, the amount of the invoice. The factor, in turn, passes the remaining, say, 20% of the face value of the invoice to the seller minus any agreed fees and interest charges.

Factoring is riskier than some forms of supply chain finance since the funds are advanced by the factor without knowing whether the invoice has been approved. Under factoring, there’s a higher risk of fraudulent invoices being presented for finance.

Since funds are advanced before the buyer approves the invoice, hence, effectively confirming its authenticity. For these reasons, factoring tends to be quite an expensive form of finance despite being very useful to fast-growing businesses.

Rich Williams: Could you tell us how factoring differs from receivables discounting and invoice discounting, please?

Marcus Hughes: So at a high level, receivables discounting and invoice discounting are to a large extent the same thing. They’re both forms of finance in which the supplier sells individual or multiple invoices to a finance provider at a discount. So like factoring, under a receivables discounting facility, the supplier’s receivables are assigned to the finance provider which advances a percentage, normally up to 80% of the face value of those invoices.

But unlike factoring, the supplier is responsible for managing its own sales ledger and collecting the trade debt. This inbound cashflow is then used to reimburse the financing. Usually, the buyer settles invoices by paying them into a collection account in the supplier's name, which is managed by the finance provider, which then passes the net balance to the supplier after deducting the value of advances and interest charges.

Typically, receivables discounting is designed for larger, more credit worthy customers. Whereas, factoring tends to be better suited to smaller, fast growing companies wishing to improve their cash flow.

There are a number of new financing techniques coming onto the market which use artificial intelligence to assess the risk of non-payment or late payment and reduces this risk through credit insurance. There are also invoice marketplaces where invoice finance can be obtained through an auction process to get the best price for finance.

All of these exciting new tools are making useful additions to the range of finance instruments that are available to suppliers.

Rich Williams: Now, these are all fairly well established means of seeking efficiencies. So are there any new payment instruments which are going to help businesses to get paid more quickly, please?

Marcus Hughes: Yes, that's right. There's a new payment instrument in the pipelines here in the UK and some other geographies, which should prove very useful in helping suppliers to get paid more easily. It's called ‘request to pay’. This new way of getting paid combines an electronic invoice with a number of payment options. So here's, kind of, how it works at a high level.

The payee, that's the party wanting to get paid, uses a cloud based payment platform or an app to issue an electronic message called a request to pay. This is sent to the payer. In other words, the debtor or the party who owes the money, and the request to pay includes the description of what the payment request relates to.

For example, in closing details with the invoice in the message and on receipt of the request to pay on their app, the payer is offered a series of payment options. For example, either to make payments for the total amount requested immediately or to make a partial payment or even to request an extension before paying.

Other options include, the ability to send a personal message to the payee, to decline the payment, or even to instruct that any future requests to pay from a particular payee should be blocked. Now, naturally, all these decisions are communicated back to the payee who will take appropriate action.

A big advantage for the party getting paid, especially for a business handling high volumes of inbound payments, is that they'll be able to achieve automatic reconciliation of inbound funds by using this request to pay. This is because full details of the payment and the payer are included in the payment, of course.

There’s some flexible request to pay tool [sic] as many compelling user cases in the person to person, business to consumer and business to business spaces. So, for example, an individual can use request to pay to ask friends to reimburse him for their share of a dinner, which he or she has paid in full.

Alternatively, a utility can send a request to pay to a customer who prefers not to use direct debits because this particular customer wants more flexibility. But, likewise, in a business to business scenario, an organisation can use request to pay to present an invoice for payments.

The request to pay has been designed in such a way that more than one level of approval can be required before the request to pay is issued or authorised, hence, making it suitable for businesses. So as request to pay becomes more sophisticated over time, it's expected that the payment options will incorporate aspects of supply chain finance or invoice finance.

So if a supplier wants to get paid early, it can offer a discount. And if the customer seeks deferred payment terms, then an interest calculation will be added to the amount due, reflecting the time value of money for paying at a later date.

So you see that the request to pay has tremendous potential for streamlining this whole order to cash and purchase to pay cycles. And with the introduction of request to pay, it seems that at last, payments and invoicing, are going to be fully integrated with the whole payment system, as opposed to traveling separately.

This in turn creates an ideal environment for improving visibility, mitigating risk, and making it easier for businesses to access finance at more competitive rates.

It's expected that early examples of the request to pay service will be launched this year. So it's exciting times in the near future. I would emphasise that request to pay should not be regarded as a threat to direct debits. In fact, I'm convinced that request to pay will complement direct debits rather than reduce direct debit volumes.

It's more likely to become an attractive alternative to payment service users who require greater flexibility regarding the date and the amount of their recurring payments. So a business collecting large volumes of recurring payments is likely to find the request to pay becomes a very valuable addition to their direct debit arrangements.

Rich Williams: Is request to pay only for the UK, Marcus, or are other countries adopting the same or very similar models?

Marcus Hughes: That's a really topical question, that one. There are several versions plans, which can be a little confusing. Although they are similar, these different versions of request to pay are not identical.

So once again, the payments industry faces that risk of fragmentation. Unfortunately, this has happened all too often in the past. So in the US, the clearing house is developing their own version of a B2B request to pay for their real-time payment system. In Europe, EBA Clearing is developing a pan-European request to pay.

And finally, SWIFT is developing a cross border request to pay. This major SWIFT initiative is part of their GPI or Global Payments Innovation Programme and it's a response to the challenge faced by treasurers that there's currently no standard for cross border collection instruments. Although many countries have their own domestic instruments like direct debits.

So in response to demand for easier cross border collections, SWIFT and their partners are developing a cross border request to pay instrument, which has great promise for the future.

Rich Williams: So it seems clear that request to pay has got an exciting future ahead and should help businesses to get paid more efficiently, more flexibly, and ideally more quickly.

I've also heard that PSD II, that's Payment Services Directive will allow online merchants to get paid sooner and reduce their credit or debit card fees. Could you explain how that can actually be done?

Marcus Hughes: They're absolutely right. PSD two is an important opportunity for online merchants to cut the cost of getting paid by card and to receive cleared funds faster. Because of their convenience and ease of use, credit and debit cards are today the main way in which online merchants are paid for goods and services by consumers and by businesses. But the fees of its merchants pay to acquire those processes and card networks are very high compared to other payment types. Sometimes 2% or more of the value of the goods purchased. This means that many millions, if not billions of pounds of card fees are being paid by online merchants, which rely on cards as an easy way to get paid.

So in order to reduce these high card fees, online merchants can now start using PSD II either to become a payment initiation service provider themselves or to partner with someone like Bottomline Technologies. And this will enable an online merchant to obtain payment direct from their customer's bank accounts.

And as you mentioned, Rich, settlement will be in real time using faster payments or SEPA Instant Credit Transfers. On the other hand, card payments usually take a few days to reach the merchant’s accounts and it will be less expensive than card payments, of course. There are even predictions that card businesses could see a drop in revenues from online card payments, even if other areas like contactless payments looks set to continue growing rapidly.

By making it easier for customers to use direct account to account payments under PSD II, an online merchant will be able to make its customers’ paying activity a more seamless part of the buying experience. And it will be a more secure process because the customer does not need to hand over its card or bank account details.

Rich Williams: As this episode draws to an end, do you have any closing remarks for listeners please, Marcus?

Marcus Hughes: Yes, I’d summarise by emphasizing that the late- Well, the problem of late payments of invoices is very widespread. It's especially painful for small and medium sized businesses, which are often waiting long periods beyond the agreed terms to get paid and they can experience difficulty in accessing finance at competitive rates.

So in a perfect world, late payments would not exist. But so far, regulations have had little effect and it's therefore more practical to put in place a number of technology and finance techniques which can help to reduce the volume of late payments and mitigate their impact on cashflow.

As we’ve seen, there are plenty of best practices and technology solutions out there which enable buyers and suppliers to reduce the occurrence and the impact of late payments.

Ultimately, there may also be a case for the regulator to get tougher on businesses, which report poor performance in their duty to report statistics. The government should start to impose fines on the worst offenders, for example. And I think that would show the government means business.

Rich Williams: So once again, we've covered an awful amount of content there, and that just leaves me to thank you, Marcus, once again for joining us and sharing your insights and experience with me and, of course, the listeners.

Marcus Hughes: My pleasure. Thank you, Rich, and see you again soon, I hope.

Rich Williams: Unfortunately, that's all we have time for today. We'll be back with some more podcasts very soon. And in the meantime, you can listen to more episodes on all things payments at the touch of a button using your preferred provider, and we'll see you all next time.


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