Small Business Financing

Cash-Flow Crisis Is Recession's Legacy for Small Biz


Custom cabinet seller M&J Kitchens survived the Great Recession even though its revenue from homeowners and builders dropped by more than half in 2009. Then, last August, with sales tracking 42 percent higher than a year earlier, owner Drew Davies shut the East Greenwich (R.I.) company after 26 years, unable to pay his bills. M&J was a casualty of a cash-flow crisis precipitated by his bank and trading partners who, Davies says, abandoned payment agreements that had been in place for decades.

More than a year into the official recovery, small businesses face what some say has become a permanent legacy of the recession: Their vendors are demanding faster payment even as their customers are taking longer to pay. Companies with the least bargaining power get squeezed the hardest. "The slowdown of currency, of money, the exchange, put us in a very precarious position," says Davies, 50. "We basically had panic from our vendors."

The problem that helped put Davies out of business is growing. The average time private companies took to collect accounts receivable increased to about 27 days in 2010 from about 23 days, the level it had been for the previous four years, according to data from accounting software maker Sageworks, which collects and analyzes financial statements from thousands of private companies. Likewise, average payment times jumped to about 24 days, up from 20 or 21. The largest corporations take even longer to pay. Companies in the S&P 500 paid vendors in 59 days on average in the most recent quarter and collected payments in 46 days, according to data compiled by Bloomberg.

Delinquent Dollars

Even as companies push for more time to pay their bills, more are falling behind the terms agreed on, data from credit bureau Experian show. In December, 14.3 percent of dollars owed were delinquent, vs. 12.5 percent at the start of 2010. The average time late payers took increased as well, to 6.5 days in December from 5.8 at the start of 2010.

In Davies' case, he had to float his own commercial customers—builders, architects, and home remodelers—who had slowed their payments, typically from 30 days to 60 or 90. At the same time, his own suppliers changed agreements that had been in place for decades by cutting credit lines or requiring deposits, which Davies says could tie up between $60,000 and $120,000 per month.

The late payments rippled through the supply chain. At Wood-Mode, one of the cabinet lines Davies sold, customers that normally pay in 30 days are taking closer to 60, and fewer are taking advantage of discounts for paying in 10 days, says credit manager Nick Yoder. In general, he says, the 1,100-employee Kreamer (Pa.) company has not changed terms and tries to be flexible with its 1,200 dealers, though in some cases Wood-Mode has begun asking for larger deposits or payment on delivery when buyers appear risky. "We have to reassess each individual's credit as different orders are placed with us, and we're reviewing how much we're going to give them as far as a credit line," Yoder says.

Changes in vendors' payment terms can have seismic effects on small businesses, particularly when bank credit is tight. Though Davies says he was current on his bank loans—an $800,000 commercial mortgage on his showroom and a $200,000 credit line—his lender called them in last March, saying he had violated a loan covenant that required a certain ratio of assets to liabilities. M&J Kitchens, which once employed 12 people and grossed $3 million to $4 million a year, went into receivership at the end of August. The business was one of 85,000 commercial bankruptcies in 2010, a figure up 30 percent from 2008, according to bankruptcy data provider AACER.

"New Normal"

Longer terms are part of the "new normal," says Joe Reini, founder of the 28-employee engineering services company Mason-Grey. "It seems to me that 'net 30' is gone," he says, referring to the practice of paying invoices in 30 days. "Customers are now asking for 45, 60, some are even asking for 90 or 120 days." About half the Atlanta company's customers, which include large industrial companies in pharmaceutical, energy, and metals production, have sought longer payment terms, Reini says.

Since 2009, he has been speeding up his cash flow by selling some of his invoices on The Receivables Exchange, an online marketplace where investors pay cash to buy unpaid invoices at a discount. Nic Perkin, co-founder of the New Orleans-based exchange, says larger companies stretching out their payments is a prime reason small businesses choose to sell their receivables. "The large corporations are in a position to drive terms. One of the terms they can drive is the payment cycle of their supply chain," he says.

The longer payment periods clog the pipes of commerce. Mike Mitternight, president of Factory Service Agency in Metarie, La., says about one-third of his revenue "is tied up in longer-than-normal terms." The nine-employee commercial air-conditioning contractor, with sales of $1.5 million to $2.5 million, installs and maintains AC systems in such places as churches, schools, and retailers. "The big chains are holding on to their money longer," he says.

The shift, which he says affects at least 40 percent of his accounts, means he can only buy from certain manufacturers "who will allow a little extra float." Mitternight avoids other suppliers that demand payment in 30 days when he knows his customers won't pay that quickly. Accounts receivable ballooning on his balance sheet makes Factory Service Agency look weaker on paper to potential lenders and insurers who provide the bonding needed for government contracts. "It's hard to expand and grow your business," he says.

Davies, of M&J Kitchens, says his vendors unintentionally helped cause the thing they were trying to prevent: By tightening their credit terms to reduce the risk of him not paying, they pushed him into receivership. "Without the cash flow we were used to and without the terms we were used to, we didn't have great negotiating power with the bank," he says. "We were getting squeezed from both sides."

John_tozzi
Tozzi is a reporter for Bloomberg Businessweek in New York.

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