When large corporations go under, the contractors and subcontractors who worked with them are often left holding the bill. Often contracted on payment terms of 60 days or longer, subcontractors still need to pay employee entitlements and tax on months of work for which they themselves were never paid. This financial knock-on effect can impair growth, or, in severe cases, even lead to insolvency for these businesses.
A 2015 Senate Inquiry into the issue found that insolvencies in the building and construction sector that year left related businesses with over $3 billion in unpaid debts. To protect their own futures, and to ensure that they can continue to grow, subcontractors and small business suppliers need to find ways to minimise the impacts of corporate failures, and to manage the resulting financial fallout.
Managing payment terms
In Australia, big businesses still commonly operate on standard payment terms of 60 days or longer with their suppliers and subcontractors. Moreover, as they begin to experience serious financial difficulties, they sometimes begin delaying payments to subcontractors. Anecdotally, it’s not uncommon to hear of subcontractors being forced to wait 6 months or longer for a client payment before that client actually goes into administration. At this point, they’ll likely lose not only this, but also all subsequent payments that they’re still owed.
In their attempts to rescue their own finances, these larger businesses effectively attempt to borrow money from their suppliers and subcontractors. This, in turn, maximises the financial impact on those suppliers when they go under. To protect themselves, it’s essential that these smaller businesses work to minimise their payment terms, and react strongly to red flags such as increasingly delayed payment. The prime minister’s recent announcement that government contractors will be required to adhere to 20 day payment terms by the middle of 2019 will likely help, but it won’t protect subcontractors of businesses who don’t work directly with the government.
Avoid the sunk cost fallacy
Businesses who are already owed a significant amount by a client may feel obligated to stay with them in order to attempt to secure their payment. After all, leaving a client might be exactly what forces them to fold. This, however, can be a big mistake. By waiting to terminate a contract due to non-payment to avoid losses, businesses actually allow the potential damage to increase over time. Worse, when the client eventually goes into administration, they aren’t prepared, and need to start from scratch to find new customers who can help them recover.
Businesses who, instead, begin looking for new clients the moment they believe that an existing partner is in serious trouble will be in a far better position to deal with the problem. Additionally, they will be able to exert more pressure on non-paying clients to pay up or lose them as a supplier.
Use financing to manage cash flow interruptions
Minimising the potential impacts of a major client’s failure is important, but it can’t fully protect a business’ operations. After all, most SMEs still can’t afford to unexpectedly lose 20 or 30 days’ revenue. To manage this, they need fast financing options that can help keep operations running in the short term, and buy the time needed to adjust to the change.
Supply chain finance
To ensure that a business’ own suppliers are affected in a type of cascading domino effect, it’s a good idea to make use of supply chain finance. Supply chain finance is a way for business to pay their suppliers out of a credit fund, rather than their own pocket. This means that sudden pressure on your working capital won’t immediately translate to late payments for your own suppliers. Rather, you can continue to pay normally, and defer payment on your balance until a later time.
Unsecured business loans
Businesses who need to come up with additional funds to manage miscellaneous expenses can turn to an unsecured business loan. Unlike traditional loans, these can be processed in as little as 24 hours, which makes them uniquely well suited for reacting to sudden and unexpected cash flow interruptions.
Corporate failures are a big problem for the SMEs who rely on subcontracting relationships with them. While the government’s steps to manage late payment times is likely to mitigate the damage somewhat, businesses need to take steps on their own to protect their interests. By being conscious of the potential damage a late-paying client could do by going into administration, and acting accordingly, SMEs can ensure that if their clients run into trouble, they and their suppliers won’t be forced to pay the price.