What to Do When Your Customers Do Not Pay

Like many CFOs in economically vibrant Asia, S. Venkateswaran has been seeing new names being added to his company’s client roster now that the global financial crisis appears to have waned. “But we’ve only been consciously looking for A, B and C customers,” says the Group Finance Director of Mulitex, one of Hong Kong’s oldest garments makers.

The company used the crisis as an opportunity to look hard into the quality of its customer list and effectively purge the rolls of D and E clients – customers that had excessive delays in, or defaulted on, payments – while lowering the credit limits extended to B and C customers (small and mid-sized companies with fair-to-good payment records) and refocusing on A clients (trusted and large buyers).
Now that the global economy appears to be back on track, Mulitex is aggressively expanding and acquiring new accounts, particularly in the growth areas of South America and Asia. “But you don’t really know whether [the new clients] really belong to the ABC categories,” Venkateswaran observes. “You don’t know whether they really are Ds and Es trying to act like ABC companies.”
That’s one of the dilemmas that finance in Asia faces these days. Sales and marketing are finding (or are approached by) many new customers, particularly from emerging markets like the BRICS countries – that’s Brazil, Russia, India, China and South Africa. But there is not much that people here know about them.
“It’s very difficult to assess somebody absolutely well, so to some extent you have to go with your gut feel,” says Venkateswaran. “Many customers are not as transparent as we would like them to be, even listed companies.”
You don’t want to turn away business, especially in fast-growing emerging economies that are encouraging domestic consumption. On the other hand, you want to get paid too, and equally important, to make sure that the nascent relationship can become a durable and lucrative one.
Delayed payments
This dynamic is evident in the new CFO Innovation insight survey, Receivables After the Crisis: Asia’s CFOs & Elevated Risk. Sponsored by credit insurance provider Atradius, the research surveyed 184 CFOs, finance directors, controllers and other places in Asia in March this year.
A key finding is that a large majority of companies are experiencing delayed payments. The worst of the global financial crisis may have passed, but only 25% of the executives surveyed say that customers are generally paying according to terms. Three-quarters of respondents are seeing payments that are late by 15 days or longer.  
This is not exactly a new phenomenon in Asia. Coface, another credit insurance provider, surveyed companies in China three years ago, some time before the financial crisis became full-blown. Nine out of ten of the executives experienced overdue payments on domestic sales.
“This does not appear to be a function of financial distress, but a practical way to manage finances in an environment where bank borrowings can be difficult,” the CFO Innovation report speculates. Adds Atradius: “Individual countries in Asia, like those across the rest of the world, will have their own business cultures and operate within differing interpretation of ‘acceptable delay’.”
But it is telling that 49% of respondents in the CFO Innovation study say they are seeing an increase in the number of customer requests to lengthen payment terms, compared with the volume of such requests 12 months ago.
This Asian trend mirrors the situation in China that Atradius detected last year. In the Atradius Payment Practices Barometer – Summer 2010, 81% of the surveyed companies in China said that their customers had asked for extended payment terms in the past six months.
“Even though the Chinese economy never slipped into a recession . . . Chinese companies still had to deal with the impact of the global recession on their customers,” that Atradius report concludes.
Are we worried yet?
In Asia, one positive trend is that payment defaults appear to be staying largely at the same level as before the crisis – 46% of respondents in the CFO Innovation survey say this was the case last year. Only 17% had experienced more customer defaults in 2010 compared with before the crisis. Thirty-six percent even say they saw a decline.
Even so, the executives surveyed say they are more concerned today about delayed payments or defaults than before the crisis. While a relatively high 39% say they are less worried, 51% do express intensified concern.
This is not surprising “given the continuing unemployment and budget problems in the U.S. and the economic crisis in Greece, Ireland and Portugal,” notes the CFO Innovation report. One can add to this mix the fears about what looks like a property bubble forming (or already having formed) in China. 
The level of concern may have possibly even risen in the wake of the earthquake and tsunami that laid parts of Japan to waste, causing a nuclear disaster that’s still continuing and plunging the economy into recession. Fieldwork for the study was completed before the earthquake.
And if Mulitex’s experience is anything to go by, the return to growth and expansion by Asian companies may be adding to the unease. In starting a relationship with new customers in non-traditional markets, companies have to make a leap of faith about the creditworthiness of the new counterparties.
It’s a situation made more complicated by the possibility of a double dip recession, if the US fails to raise its debt ceiling, for example, or if Europe gets contaminated by the economic meltdown in its periphery.
Companies can turn away new business, of course. But this better-safe-than-sorry course can lose them market share and may prevent them from fully participating in the emerging markets’ story.
As the CFO Innovation report puts it: “As new businesses spring up in China, India and other ASEAN markets, the overcautious company that insists on dealing only with the tried-and-true may lose out.”     
Managing elevated risk
So what are companies planning to do to mitigate payment risk? It seems the default response is still the better-safe-than-sorry route. Asked to identify the one key strategy they will adopt in the next 12 months, 40% of respondents say their company will require customers to make advance payment, while 15% will ask them to open a letter of credit.
Some 18% will buy credit insurance, which in theory will allow greater flexibility in taking on new and untested buyers because the company is protected if something goes wrong.  
However, while agreeing that credit insurance can be useful, Mulitex CFO Venkateswaran is deterred by the cost of taking out protection. “There are very few companies that will give you selective trade credit insurance,” he complains. “They would want to underwrite the whole turnover.”
Atradius says it does cover selective trade credit insurance. “We offer a range of differing types of cover, including both single situation and whole turnover cover,” it says. “We specialise in flexible solutions to suit our clients’ requirements, wherever they may be trading in the world.”
What companies must understand, says Atradius, is that “the key role of trade credit insurance is to protect businesses not from what they do know, but what they don’t. For many businesses, this means protecting and advising them as they begin trading with new clients or in new markets. For others, particularly in the current global economic climate, this means giving them some extra security should a long-trusted buyer fall prey to poor economic circumstances.”
That’s fair enough. There is no free lunch, as they say. For Asia’s CFOs, the course to take will depend on the company’s appetite for risk set against its desire for future growth.
Is the appropriate strategy to stay largely with tried-and-true customers and possibly expand the business at the same pace as these clients are growing, or should they take a chance and also take on untested clients, but make sure their receivables management is robust enough for the task? 
About the Author
Cesar Bacani is Editor-in-Chief of CFO Innovation. He devised the questionnaire, analysed the results and wrote the Receivables After the Crisis report.

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