Fire Sale: Turning Bad Debt into Positive Cashflow

Cashflow. It’s what keeps businesses alive. Those that manage their cashflow well inevitably prosper and grow. Conversely, those that don’t face a constant battle to survive. Liquidity, however, is far from being a recent challenge. While the COVID-19 crisis has certainly served to underline its importance, it’s something that concerns every CFO or financial director on an almost daily basis.

It must be said that even well-run and well-financed fire and security businesses with professional credit management teams suffer from late payments. Installers find themselves chasing customers for residential or commercial installations or unpaid service and maintenance contracts. Distributors chase installers for product long-since delivered, but not yet paid for, while the manufacturers themselves can struggle with payments from both installers and distributors alike.

A common theme across all is that they typically have a large volume of comparatively small value invoices to collect and have to balance at what stage the cost of collections becomes disproportionate to the amount overdue. When their own collection activities are exhausted, the only option left is the courts, but this costs even more money, takes time and there’s still no guarantee they’ll receive any money at the end of the whole process.

Consider this, though. What if the CFO was given the opportunity of turning a potential bad debt write-off into positive cashflow? To put it another way, what if a business could effectively ‘sell’ its beyond-term invoices for cash? In doing so, what if the industry helped to effectively create a new ‘category’ of debt management solutions available to the hard-pressed CFO?

Debt management

The concept of selling debts, of course, is not a new one, but it’s new to the world of commercial credit. In the consumer space it’s big business with major and established players dominating a multi-billion-pound industry, but whereas the acquisition of large consumer debt portfolios (eg credit card debts, non-performing loans, utility bills, etc) is de rigeur, the acquisition of portfolios of delinquent commercial debt is not so prevalent. Those commercial debts that have been purchased have almost always been sold by default, tending to be part of a tranche of small commercial debts bundled within a much larger portfolio of consumer accounts. It has been far less typical for a business to actively seek to buy a commercial portfolio in isolation. Until now, that is.

So how does this new solution work? The debt ‘buyer’ values a tranche of debt at anything between (typically) 5% to 50% of its face value. Based on its valuation, this is the amount that the ‘seller’ (ie the fire and security business) receives at completion. The value is determined by a number of different factors, the two most important of them being the age of the debt and the credit profile of the debtor. A recent invoice to a large, well-established business is likely to pay a much higher percentage than a very old one to a smaller business.

The only restrictions relating to the invoices purchased are that they have to be ‘younger’ than six years from the due date and of a value greater than £100. There are no restrictions, however, to the volume or make-up of the portfolio. They may comprise a small number of large invoices or a large number of small invoices, so long as they have a total value of £50,000 and above (up to a maximum of £10 million).

Once the invoices have been acquired, the responsibility of collecting the outstanding balances rests with the purchaser. They will use a range of skills and credit reference agency data to determine the appropriate servicing strategy (ie the collection techniques most likely to result in a successful outcome for all parties). It’s those skills and insight, also, that will identify any vulnerable customers, allowing forbearance and breathing space where and when required.

Acquiring consumer portfolios

Of the money that’s collected, the purchaser shares a proportion of the collections it achieves, which can be as much as 50%, with the amount remitted to the client on a monthly basis.

When businesses first started acquiring consumer portfolios two decades ago, the biggest barrier to sale tended to focus on concern for client reputation once the relationship was no longer under its direct control. There is, perhaps, still the potential for similar concerns to be expressed in the selling of commercial debts, but by being authorised and regulated by the Financial Conduct Authority, CFOs and their peers in brand can be assured that businesses like ourselves adopt a fair and balanced recoveries process, with a creditor’s brand reputation being of the upmost importance.

A relationship with such an authorised investor is then based on partnership and transparency. Seller oversight of the collection process is welcomed, with contractual seller consent often being required for any change of servicing company or collection strategy.

However, this doesn’t mean that it will not consider taking action against those who clearly have the means to pay, but for whatever reason are failing to engage in an amicable contact strategy. In such examples, and as a last resort, legal action may be required. For our part, we use a combination of bureau data and the expertise of a panel of preferred collections partners to ensure that only the right cases are selected for litigation.

Redefining cashflow finance

There are, of course, other ‘cashflow funding’ options available. The Government has gone out of its way to support businesses with various loans, grants and other hand-outs, but while the Coronavirus Business Interruption Loan Scheme takes time to establish itself, many cannot afford – quite literally – to wait.

Businesses might therefore look towards more ‘traditional’ methods of cashflow funding including various forms of invoice finance (factoring, invoice discounting and asset-based finance, etc) where the amount of money available is directly linked to the invoices generated. Again, such financing has its drawbacks and relies on a constant flow of business and invoicing. As business dries up, so does the cash.

Providers of invoice finance advance cash against invoices that are still within term (ie 30 days), whereas we provide cash for debts that are overdue or delinquent, and that a business is either struggling or has simply failed to collect.

This is an important distinction. Whereas the amounts advanced (typically 80% of the invoice/sales ledger value) appear much higher than the amount offered for debts that are sold, they’re not comparing like-for-like. Very few CFOs realise that there’s any value in delinquent debt. Fewer still, perhaps, are aware that such unpaid invoices can be instantly converted into cash. Cash that can be used to invest. Cash that would otherwise have simply been written off.

It’s probably fair to suggest that there has never been a more important time for businesses to be able to extract value from their unpaid debts. As the Coronavirus pandemic leads to more businesses failing to pay their suppliers, businesses further up the supply chain need to make sure they don’t run into liquidity problems. We’re playing our part by committing to provide cash against at least £1 billion of UK businesses’ unpaid invoices.

Critical importance of cashflow

If there’s an upside to the COVID-19 crisis it’s that it has once again obliged businesses to look at their most important asset and understand the critical importance of cashflow. The speed with which some businesses ran out of cash during the present scenario has been alarming, but the speed with which others re-focused their credit teams was rather more uplifting.

Interim Small Business Commissioner Philip King, whose own office champions fair payment practices and supports those businesses looking to resolve payment disputes, has said that “...at times like these we need creative ideas”.

Commercial debt purchase – and the emergence of a new genre of debt management solution – is one such ‘creative idea’ that’s highly likely to have traction long into the future.

Andrew Birkwood is Founder and CEO of Azzurro Associates