FINANCE - 05.02.2013

How to incentivise prompt payment

The Prompt Payment Code

In the past few weeks Vince Cable, the Business Secretary, stressed that the late payment of invoices remains “a real issue” for many small and medium-sized companies who “cannot survive without a steady cash flow” - talk about stating the obvious! At the same time, he urged more large businesses and local authorities to sign up to the government’s Prompt Payment Code (PPC). We reported on this in a previous article (yr.10, iss.13, pg.5, see The next step).

Two big problems

Whilst this is all very noble, there are two problems with the PPC. Firstly, it’s voluntary and secondly, if a large business, or organisation, does sign up but subsequently ignores the “agreed practices” for whatever reason, no penalties are imposed on them. So, therefore, the PPC looks good on paper but doesn’t have any teeth. However, there’s no reason why you can’t have prompt payment incentives of your own.

Offering a discount

By and large, companies usually issue invoices with strict payment terms; for example, “This invoice must be settled within 30 days”. To tempt early settlement, let’s say within 14 days, a small discount, e.g. 5%, could be applied to that outstanding amount. If we imagine that the original invoice was for £1,000, this is a £50 reduction if the monies are received early. That might sound like a lot, but if the purchaser took the bait it would mean £950 in the company’s pocket two weeks early without the hassle (or cost) of chasing for payment.

Tip. If your company is VAT registered, the invoice must show the full product, or service, price and the discount applied. However, when it comes to calculating the VAT, this is based on the discounted rate. What’s more, it doesn’t change even if your customer later pays the full rate, i.e. because they missed the discount deadline.

Ramping up the interest

To make this small discount incentive seem even more attractive to the purchaser, there’s something else that the directors can do: state on the invoice that interest will be applied to the full outstanding amount from the first day that payment becomes overdue, and the rate you will use. Many companies miss a trick here because they don’t apply interest to unpaid invoices until payment is 30 or 60 days late, or until they (or their lawyers) start threatening court action over the debt.

Note. If you don’t state a specific late interest rate on your invoice, you will be stuck with the county court rate, which is currently 8%. That’s OK, but the directors can go one better.

Tip. Increase the rate on overdue payments to, say, 15%. Any higher and there’s a risk that the company could run into problems - the courts may view a higher interest rate as a penalty. When the purchaser sees that they could pay £950 in the first 14 days (or £1,000 thereafter) as opposed to £1,012.32 if they are 30 days late, they should be keen to pay your company promptly.

For a link to the previous article (CD 14.09.02A) and to see the details behind the interest calculation (CD 14.09.02B), visit http://tipsandadvice-companydirector.co.uk/download.