Payment Backlogs: Big Problem for Small Businesses

payment-terms
Nick Youngson || CC BY-SA 3.0

The low rate of private investment limits the capacity for growth of Polish economy. In comparison with other countries in the region, Poland stands out due to the lowest rate of investment. In the last ten years, business investment in the new EU member states from Central and Eastern Europe amounted to, on average, 16.1% of GDP while in Poland only to 10.7%. The low investment rate means less machinery and equipment in companies, lower productivity and, consequently, lower wages. The problem of too little investment is also reflected in the size of Polish enterprises – the ratio of their assets to GDP is among the lowest in the EU.

Among the main driving forces of modern economic growth are far-reaching specialization and the emergence of increasingly complex value chains. Cooperating companies use trade credit, which is a deferred payments system. By design, this provides an effective solution, because the contractors often know about each other a lot more than their banks. As a result, the cost of trade credit can be much lower than the cost of bank credit.

Trade credit should not be considered as a substitute for bank credit – we cite research showing that trade and bank credits are to a large extent complementary. At the same time, however, lengthening of supply chains and growing importance of deferred payments, means that problems of individual enterprises can quickly spread to cooperating companies. Therefore, although on the one hand trade credit facilitates closer cooperation, on the other hand, it makes the company more vulnerable to payment backlogs.

Payment backlog is an intuitive concept, and thus it is dificcult to provide a precise definition thereof. While one can easily determine which payments are not delayed, payments made after the date specified in a contract do not automatically classify as backlogs. Possible causes of the delays vary: from the bankruptcy of a contractor, through his/her ill will (he/she could pay, but simply does not do it), to disputes concerning the quality of the supplied goods, or are simply the result of a time-consuming procedure.

The cost of payment backlogs is not limited to the cost of maintaining the liquidity of the company. In addition to the interest on bank loans (assuming that the company has access to credit), one should also take into account all the additional costs associated with the monitoring of payments from contractors, chasing late payments, and growing risks caused by the delays. It is even harder to determine additional costs associated with the reduction of investment and the scale of operations caused by disturbances in the financing of such companies.

In a study commissioned by FOR in preparation for this report, in accordance with the established practice of the study of this topic, we asked entrepreneurs about the total costs incurred to their companies by payment backlogs (which are not limited to purely financial expenses). It turns out that the scale of the problems with payment delays at the macro level is strongly linked to the economic situation – problems with backlogs are rising during slowdowns. During the economic slowdown of 2011, payment backlogs were the biggest barrier to investment for small and medium-sized enterprises (SMEs).

Payment backlogs generated largest costs in the construction and telecommunication sectors, while the lowest – in the industry. Low cost of payment delays in the industry is probably the consequence of a stable portfolio of large customers, who are easy to monitor and easy to press in the case of delays. However, we did not find direct evidence of a link between the increasing size of enterprises and the sector in which they operate.

The results of the study commissioned by FOR show that the entrepreneurs who had problems with payment backlogs as their main reasons identified bankruptcy of contractors and payment backlogs that their contractors experienced themselves. These results indicate that backlogs which occur at one point in the supply chain can spread to the cooperating companies.

One should note the importance of the informal economy – for companies operating in sectors with a significant share of shadow economy (e.g., construction) the risk of payment backlogs is four times greater. Entrepreneurs who hide parts of their business to avoid taxation are also less honest and are more likelt to comply with timely fulfillment of their obligations to suppliers. As payment delays in one company can easily spread to another, enterprises that honestly pay all their taxes may suffer from backlogs of their business partners operating partly in the gray zone.

Our results indicate significant differences in the perception of the causes and effects of backlogs, both among the companies that actually experienced them, and others. Although payment backlogs are not a particularly strong barrier to investment to enterprises, in general, their significance is larger for those businesses that experienced the problem. In other words: for over a quarter of all Polish enterprises payment backlogs are one of the most important barriers to investment growth.

Companies that experienced payment backlogs in the past use much more security when entering into new contracts. Moreover, they also more often resort to legal measures and reporting to debtor registers. When it comes to preventing payment backlogs, information about delays in public-law payments and in private payments is reported as equally significant by enterprises evaluating potential contractors – in both cases, 80% of them would disqualify such a candidate.

Problems with payment backlogs cannot be solved easily by legislation – they need to include a much wider range of activities, both by economic authorities, as well as industry associations, and companies themselves. This is not only Polish issue – SMEs in other countries face the same problem. However, a law requiring companies to pay on time is not an answer – the contractor would still not pay on time in the case of bankruptcy or when the quality of the delivered products is not satisfactory. Furthermore, even if there is a possibility of redress in court, companies adopt such solutions only as a last resort, not wanting to antagonize its customers.

Therefore, we provide a much broader set of recommendations:

  • for the government, we identify the need to take measures to reduce the shadow economy and to facilitate access to information on public-legal liabilities, which will allow companies to evaluate the credibility of potential contractors more accurately. The government should also take care of the favorable conditions for innovative companies seeking market solutions to problems of backlog (e.g.,. micro factoring);

  • for business associations, we emphasize the need to develop and enforce standards for both payment terms, and quality of supplies. Developing and maintaining standards can be helped by certificates awarded to reliable companies timely fulfilling their contractual obligations;

  • for the enterprises, we recommend that in addition to timely paying their own bills they should make a greater effort in verifying the reliability of contractors as well as use the services of credit bureaus more widely – not only in a passive way (by downloading information), but also actively (by reporting unreliable contractors);

  • in the light of a limited efficiency of courts in the fight against backlogs, the crucial factors are: improving access to economic information (both positive and negative) and fighting against social acceptance of delayed payments.

Full report by FOR (in Polish) available to download here

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