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Paying the price. The economic impact of big businesses paying Australian small businesses late.

This report was produced by AlphaBeta Advisors for Xero Small Business Insights.


Executive summary Late payments are a significant source of financial pain for Australian small and medium businesses (SMBs), with an estimated $115 billion in payments from large businesses to SMBs paid late each year.1 When SMBs are paid late, it pressures them financially and hampers their ability to invest, grow and employ. It also constrains economic potential. Small businesses generate a third of private-sector gross domestic product and employ nearly half of all workers. When small businesses struggle, the effect ripples through the economy.

Xero data provides insights into payment behaviour To better understand the extent and impact of late payments, this report uses data from Xero Small Business Insights (Xero SBI). It includes information on more than 10 million invoices issued by more than 150,000 SMBs. We selected businesses that had been on the Xero platform for several years and that were connected to an advisor. The data was aggregated and anonymised before analysis to protect the privacy of SMBs and their counterparts.

Because the identity of small businesses’ customers is anonymous, we’ve assumed that average patterns of late payment by all customers, as observed in Xero, also apply to large business customers. This has allowed us to create a model of big business behaviour while maintaining privacy safeguards.

Late payments to SMBs are a systemic problem Our analysis reveals a systemic problem with late payments to small businesses. Just over half of trade credit invoices sent by Xero subscribers (i.e., invoices where payment is not due until at least one day after the day the invoice is created) are paid late. These are customers of all sizes, and their payments arrive an average of 23 days after they are due.

If we assume big businesses3 pay a similar proportion of their SMB invoices 23 days late, we can estimate the national value of large businesses’ late payments. Based on Australian Bureau of Statistics (ABS) trade figures and AlphaBeta estimates, we calculate the value of big businesses’ late payments to small business is about $115 billion a year.

Long waits for payment impact business and economic health However, it’s not just late payments that impact the health of SMBs. Small businesses that endure long payment wait times, even if the invoices aren’t strictly overdue, have poorer outcomes. Our analysis shows that SMBs that are paid more slowly than average have about a third lower revenue growth than those paid faster than average. Long payment times may also have a domino effect across the economy: an SMB paid more slowly than average tends to pay its suppliers more than a week later than an SMB paid earlier.

Resolving this situation by paying SMBs more promptly could deliver a net benefit to SMBs and to the economy. If large businesses paid all invoices to SMBs on time, it could effectively transfer $7 billion in capital from large businesses to SMBs. This could deliver a benefit to SMBs of $4.38 billion over ten years by reducing their financing costs and encouraging them to invest.


1. Australian SMBs are regularly paid late Large businesses pay an estimated 53 percent of SMB invoices late.

Trade between large businesses and SMBs is a critical part of the economy. Australian SMBs sell an estimated $280 billion worth of goods and services to large businesses each year, based on ABS figures. Some of that amount is paid immediately, and some is made on trade credit, ie, by issuing invoices.

In this report, we estimate that 23 percent of small-business invoices issued by large businesses are paid immediately, with the remaining 77 percent made on trade credit. A large business is defined here as one with 200 or more employees.

Applying this percentage breakdown to the $280 billion figure above suggests SMBs issue an estimated $216 billion a year worth of trade credit invoices to big businesses across Australia.

Roughly how much of this $216 billion is paid late by big business? Xero SBI data provides a guide: when looking at SMB invoices to customers of all sizes, just over half (53%) are paid late. By assuming that same percentage applies to big businesses, we estimate the value of their late payments to small businesses is $115 billion each year.



Paying on time could deliver a net economic boost to SMBs and the economy Paying small businesses promptly makes economic sense. Presently, Australian SMBs extend an estimated $216 billion in trade credit to large businesses each year. Around $115 billion of that credit (53 percent) is paid late, on average by 23 days.

If these late payments were paid on time rather than 23 days late, it would be equivalent to $7 billion5 in working capital being transferred from large businesses to SMBs. This is because when a large business pays a small business late, it increases the receivables of the small business and reduces the payables of the large business. Ending late payments would be equivalent to an increase in the working capital of the small business and a decrease in the working capital of the large business.

If all trade credit payments from large businesses to small businesses were made on time, the impact would be the financial equivalent of large businesses providing a zero- interest in-perpetuity loan to small businesses (of $7 billion). Small businesses could respond to this loan by reinvesting this $7 billion either into reducing their net debt (thereby lowering their net financing costs) or increasing investment in fixed capital and increasing their output (if they are capital constrained).

The combined effect of lower financing costs and increased investment could deliver a benefit of $4.38 billion over ten years for Australia’s small businesses.

On-time payment would have a positive net economic impact But how would this $4.38 billion figure translate into the broader economy? Analysis undertaken for this study finds there would be a net positive benefit of $2.54 billion in net- present-value terms over 10 years to Australia from reducing late payments . This is because SMBs pay more for financing than large businesses. We assume SMBs pay interest rates of 8 percent and large businesses pay interest rates of 3 percent, based on RBA data.

This results in a net benefit for the economy because the positive effect on small businesses is greater than the negative effect on large businesses. The reason for this asymmetry is that small businesses are more credit constrained and face higher finance costs than large businesses. Therefore, SMBs have a larger financing cost benefit. We estimate the net economic benefit of the financing cost effect to be $1.99 billion in financing savings over 10 years if large businesses paid SMBs faster. This is calculated by taking the reduced financing costs of the SMBs and subtracting the increased financing costs of the large businesses.

Research undertaken by the Australian Banking Association has found that small businesses often rely on high-cost, short-term funding sources such as credit cards, or on equity-secured loans such as property mortgages.6 These funding sources have higher borrowing costs compared to bank financing.


There is also a growing divide between small and large businesses in their access to bank lending.

The Reserve Bank of Australia data shows that less than a third of total business credit goes to small businesses, and their share of total business credit has declined by 19 percent since 2011.7 Even though paying SMBs on time would require that large organisations finance the transfer in working capital by seeking additional debt, the net effect is still likely to be positive on the economy. This is because large businesses would pay lower borrowing costs, and those costs would be less than the costs to SMBs of bearing the equivalent financing impact from late payments.

We estimate that there would be a second, additional net benefit of about $550 million over 10 years

from the return on the extra fixed capital that SMBs could invest if paid promptly. The net benefit arises because SMBs are more capital constrained than large businesses. This means they are more likely to invest if being paid on time partially relieves their capital constraints. A large business, by contrast, is more likely to be able to tap an alternative financing source to replace the working capital transferred through prompter payments. For these reasons, if big business paid Australian SMBs on time, we expect it would relieve financing pressure on SMBs, helping them invest, hire and grow, while delivering a net economic benefit to the economy of $2.54 billion over 10 years.



2. Longer wait times correlate with poorer business performance

Long payment practices vary by industry.

Trade credit invoices are a long-standing and well- accepted practice between businesses. However, problems arise for SMBs when they endure long waits for payment, even if payment isn’t strictly late. This is because during the period where the SMB issues trade credit, the SMB must bear the cost of producing the goods or services sold to the customer as well as the overheads associated with running a business. This differential can quickly create cash flow and financing pressures, which in turn are likely to restrict SMBs’ ability to pay down debt or invest in the business.

Our analysis finds that among Xero subscribers, businesses in the hospitality sector get paid fastest on average, at 18 days. This includes all payments -- both on time and late -- from all customers, not just big business. By contrast, small businesses in wholesale trade wait longest for payment, on average 35 days.



SMBs that wait longer for payment grow a third more slowly Analysis of anonymised Xero SBI data for this study confirms SMBs are negatively affected by slow payments. Xero subscribers who wait longer than average grow revenue about one-third slower than those that are paid faster than the average. This should not necessarily be interpreted as a causal relationship, as many unobserved factors can affect revenue growth.



SMBs that are paid slowly also pay their own suppliers slowly Payment times may also have a domino effect through the economy. Analysis of Xero SBI data for this study found that Xero subscribers paid more slowly than average also pay their own suppliers eight days more slowly than SMBs paid earlier than average. One explanation may be that slow payment to an SMB triggers a series of further delayed payments to its own suppliers. Again, this should not necessarily be interpreted as a causal relationship, as many unobserved factors can affect a small businesses’ payment times to suppliers.



Businesses in some states are paid slower than others When we examined the payment times for all subscribers in the Xero SBI sample, we found SMBs in the state of Victoria wait the longest to be paid – typically 27 days. That’s three days longer than Queensland, the fastest-paying state in the country.



3. How can small businesses help themselves to get paid faster? It’s clear that being paid faster is tied to better outcomes for a small business. And encouragingly, the Australian government is taking steps to expedite payments. Beginning July 1, 2019, the federal government will commit to paying small business invoices within 20 days. Canberra is also encouraging large businesses to do better: Prime Minister Scott Morrison has proposed they be required to publicly report how quickly they pay smaller businesses.

In the meantime, what actions can small businesses take to help get paid faster? The first is establishing shorter payment terms. A separate, earlier Xero analysis of millions of invoices suggests this strategy may reduce waiting times.

Small businesses that set one-week payment terms waited 15 days on average for payment, ie, they were paid about

a week late. Businesses that set two-week terms waited 21 days on average – also a week late. Those with three-week terms waited 25 days.

The consistency of lateness – about a week – suggests customers may reflexively add a week to whatever terms are printed on the invoice. Factor that in when setting your terms. The second step that small businesses can take is to use automated invoice reminders in Xero. Customers can send a friendly e-mail reminder about their bill as soon as it becomes one day late. Some businesses go one better: they send a reminder a few days before the due date, which they say gets results.

The third step is to add a payment service to your invoices. In Australia, invoices created on the Xero platform with an attached payment service were paid an average 55 percent sooner than invoices without. That’s the difference between a 22-day wait and a 12-day wait. While these payment services charge a small fee, the benefits of faster payment may offset this cost.


Conclusion Prime Minister Scott Morrison called small businesses “the engine room of Australia” earlier this year, and rightly so. They generate nearly half of all jobs and about a third of private- sector GDP, based on ABS figures. Yet this engine is running below capacity due to late payments.

This report shows small businesses are effectively making an interest-free loan of $115 billion a year to large businesses, which pay more than half of SMBs' invoices late. And long waits for payment are tied to worse outcomes for small businesses: those that wait longer than average have about a third lower revenue growth than small businesses paid sooner than average. Delayed payments may also have a ripple effect. SMBs that are paid later than average pay their own suppliers 8 days later than SMBs which receive payment sooner than average.

Turning this situation around will require action from both the government and large businesses. The federal government’s 20-day payment pledge, taking effect in July 2019, is a step in the right direction. Encouragingly, New South Wales and South Australia’s governments are also making great strides, with promises to pay SMBs as quickly as 5 days from receiving an SMB invoice. They may be a bellwether for other states.

How can we get large businesses on board? The Business Council of Australia has helped lead the way, signing up 109 of Australia’s largest corporations to the Council’s voluntary supplier payment code. This is a pledge to pay small businesses within 30 days. Yet those signatories are just a fraction of the roughly 3,800 big businesses registered in Australia. It is our hope that by calculating the relatively modest cost to big businesses of paying on time, this report will encourage more large businesses to pay promptly. As we have laid out, the relief to small business would be outsized, and the economy would likely gain a net $2.54 billion over a 10-year period. If we can help more small businesses be paid on time, then all Australians stand to benefit.


Appendix: Methodology & assumptions Data sources Data for this report comes from a range of sources. The principal source of SMB data is Xero, a small business platform that supports online accounting and a range of other applications. The data used was aggregated and anonymised to ensure the privacy of Xero subscribers, and their counterparts. Our sample design entailed choosing Xero subscribers with a history that would allow us to analyse payment times with some certainty. This involved taking the whole Xero sample and selecting subscribers:

  • with a paid subscription.

  • with an advisor linked to their account such as an accountant or bookkeeper.

  • who had joined Xero before 30 June 2015.

The resulting sample of small businesses was a high-quality sample of Xero subscribers with reliable data available over multiple years.

Estimating trade credit Trade credit is defined in this report as any payment for which payment terms are extended, ie, the payment date is later than the invoice date. This excludes most immediate payments by cash and credit card. AlphaBeta economists assume that 77% of all payments to SMEs are made on trade credit. In this report, we estimate the total value of all trade credit from all Australian small businesses to large (not just trade credit within the Xero sample). The total value of trade credit is calculated from the following sources: total nominal annual sales of Australian SMBs (Value of sales based on ABS statistics reported in 8155.0 – Australian Industry 2016-17). • Total annual sales from SMBs to large businesses in Australia (ABS) calculated as the total income of SMBs multiplied by AlphaBeta estimate of the share of sales to large businesses. • AlphaBeta economists estimate of the percentage of payments from big business to SMBs made on trade credit.

Estimating payment times Payment times (the time it takes a business to be paid) and payee times (the time it takes a business to pay) are calculated in the following ways: • Payment times (the time it takes a business to be paid) are extracted from invoice-level information within Xero. This is calculated as the difference between the invoice date and the date of payment. The share of overdue payments is the total value of invoices paid after their due date, divided by the total value of all invoices. The number of days overdue is the average number of days between the due date and the payment date. • Payee times (the time it takes a business to pay) are estimated in two ways. For SMBs, the time it takes to pay another business is calculated from invoice data. Payee times are calculated as the average number of days between the invoice date and the date the business pays. For large businesses, analysis was conducted using anonymised Xero SBI data and cross-checked using ABS data.

Assumptions in analysing the behavioural patterns of big businesses Because the identity of SMBs’ counterparts are unknown, we have assumed average patterns of late-payment behaviour observed by all payers in Xero also apply to big businesses.

The anonymised nature of the Xero data precludes observing big businesses’ payment practices directly. For that reason, we have used the best publicly available data to fill out the picture.

Just over half of trade credit invoices sent by Xero subscribers (ie, invoices where payment is due at least one day after the day the invoice is created) are paid late. These are customers of all sizes, and their payments arrive an average of 23 days after they are due.

We have assumed big businesses pay a similar proportion of their SMB invoices late, and by 23 days, to estimate the national value of large businesses’ late payments.

Analysing the impact of late payments on SMBs We analysed the impact of late payments on the performance of SMBs using anonymised Xero SBI data to compare the performance of small businesses in relation to how they were paid.

  • Revenue growth: We analysed the rate of revenue growth of the Xero subscribers and compared this with their payment times. Results are based on 128,831 subscriber observations for FY15-17.

  • Accounts payable: We tested whether Xero subscribers who are paid late pay their own suppliers late. We analysed the average days it took for a business to pay its accounts payables and compared this with each business’s payment times. Results are based on 241,967 observations for FY15-17. We present this information as descriptive statistics or correlations. These should not be interpreted as a causal relationship as there are many unobserved factors that affect revenue growth and payment times.

Estimating the total economic value of late payments We used parameters from the Xero SBI data to estimate the economic impact of late payments from large to small businesses. When a large business pays a small business late, it increases receivables of the small business and reduces the payables of the large business. This is equivalent to an increase in the working capital of the small business and a decrease in the working capital of the large business.

Our approach was to model a counterfactual in which payments from large businesses to small businesses were made on time. The impact is the financial equivalent of large businesses providing a zero-interest in-perpetuity loan to small businesses. The model assumed that:

• small businesses would respond to this loan by either reducing their net debt and lowering their net financing costs or increasing investment in fixed capital and increasing their output (if they are capital constrained). • large businesses would respond by either increasing their net debt or reducing their investment if they are capital constrained. • the net effect was likely to be positive on the economy because the financing costs of small businesses are higher than those of large businesses and the volume of small businesses that are capital constrained is higher than large businesses. • Estimating financing costs. This study assumes SMBs pay interest rates of 8 percent and large businesses pay interest rates of 3 percent. Data on lending rates is sourced from Reserve Bank of Australia (2019), Statistical Table F5 – Lending Rates. • Estimating financing constraints. Data on funding sources for SMBs is sourced from Australian Banking Association (2016), The small business sector in Australia – Economic Report. Data on lending comes from Reserve Bank of Australia (2019), Statistical Table D7.3 – Bank Lending to Business. Disclaimer This report, including the insights and analysis contained within it, was prepared by AlphaBeta with the support of Xero, using Xero SBI data, publicly available data and AlphaBeta estimates for the purposes of informing and developing policies to support small business in Australia.

This report includes and is in parts based on assumptions or estimates. It contains general information only and should not be taken as taxation, financial, investment, or legal advice. Xero recommends that readers always obtain specific and detailed professional advice about any business decisions.

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