Trade credit and insolvency are inextricably linked. Often, directors of small businesses are shocked to see what is in front of them when they reach the abyss. Whilst their minds are fixated with creditor pressure, which has its own traction like a snowball down a hill, attention is temporarily lost on what caused the company’s calamity in the first place.
It is of course so often the incidence of bad debts, which is one of the most common reasons why companies enter formal insolvency.
Cash flow is the aorta of the company
Without cash flowing smoothly and playing its role in paying suppliers promptly and ensuring timely collection of receivables, it is easy to see how companies land themselves in trouble. Managing cash flow is an art form. And directors in the UK have no induction in dealing with this, let alone corporate governance, unlike elsewhere, where increasingly ‘best practice’ models exist for start-ups.
One of the main reasons why directors don’t see the writing on the wall, a state of denial, is that the kernel of the entrepreneurial idea grew out of passion. It’s their baby. Naturally, the world is looked at through rose tinted glasses through which is visible only sunny horizons and not the storm that looms.
This article by Nitin Joshi, one of the Partners here at Antony Batty & Co, explains how trade credit underpins the UK’s insolvency framework, why bad debt is so dangerous, and what steps directors can take to protect their business before problems escalate.
The role trade credit played historically – and why does it matter today, especially for SME Insolvency?
In 1983, I was the case administrator on a bankruptcy which achieved some notoriety as it was then the UK’s largest with debts of nearly £120m. The case brought into sharp focus how credit was granted. Around this time, Sir Kenneth Cork became a name edged in the minds of professionals, as the author of what became the cornerstone of the legislative landscape for insolvency. The 1977 Review led to the “Cork Report” in 1982, paving the way for the Insolvency Act 1986. All this was necessary because little codification of insolvency law existed.
It was the Review Committee on Insolvency Law and Practice commissioned in 1977 that first identified credit and placed it centre stage. It argued that insolvency law must operate to protect commerce, which cannot operate without it. It was said trade credit is the “glue” holding together a commercial ecosystem, businesses trading reciprocally. All fine. However, life isn’t about all things being equal.
At Antony Batty & Co, we know this well which is why people come to us.
A moral issue?
At its core, the Review and subsequent Cork Report, was a crusade on commercial morality.
It was argued that in the absence of a robust legal framework under which formal insolvency would operate, the “trading community” would be left with no trust. The language was blunt: phrases such as “errant directors”, the “plight of the unsecured creditor” and being “left with nothing” in a liquidation, were to the fore.
Fast forward to today. Trade credit is the “grease” of global commerce, accounting for nearly 90% of all world trade. By definition, it is usually a short-term arrangement between businesses, allowing a buyer to purchase immediately and pay later – typically within 30, 60, or 90 days. International trade is transacted with more complex instruments such as irrevocable letters of credit. But it’s still credit.
Domino effect
There are many examples.
The Carillion collapse in 2018 was the UK’s largest ever trading liquidation. With £7 billion worth of creditors, the effect was colossal. All in all, it affected some 30,000 subcontractors and suppliers.
The following year we saw the collapse of Thomas Cook. This led to the failure of some 500 Spanish hotels.
Research from 2018 indicates that 26% of UK companies were impacted by the failure of a customer within their supply chain over a six-month period. In the construction sector, it’s 47% reporting negative financial impacts from the insolvency of another business. For wholesale it’s 35% and transport some 33%.
Antony Batty & Co has dealt with its share of these unwitting casualties, providing solutions from simple to complex Creditors Voluntary Liquidations to salvage operations via Administration and Company Voluntary Arrangements. Over a period stretching nearly 30 years, the firm has practiced what it has preached. Its overarching objectives are to safeguard jobs and the business thus providing some solace to creditors that opportunities may exist to support new emerging businesses.
Known knowns, known unknowns, and unknown unknowns
Trade credit has been a feature since medieval times, with guilds and livery companies formed partly to share credit information about defaulters. Trade intelligence is a crucial tool.
I started and chaired such groups for 30 years and saw the chilling impact bad debt and insolvency has on companies left high and dry. To recover from it, they had not only to redouble their efforts to replace lost turnover but also the profit, and in small margin businesses, catch up was near-impossible, whilst meeting new liabilities as they accrued.
How did the 1970s and 1980s reshape commercial credit risk?
Credit was all the rage in the 1970s and 1980s.
Before I entered the world of insolvency, I had a spell working four consecutive summers with First National Finance Corporation. This was during the secondary banking crisis when the Bank of England stepped in with its famous “Lifeboat” operation. Again, an early insight to bad credit management, in this case, heavy gearing in the secondary mortgage market.
The 1980s saw a frenzy of activity in the courts. Industry tightened belts. The late 1970s and 1980s put Retention of Title (ROT) at the forefront of commercial practice and tested their enforceability in, for example, Romalpa (1976), Brentford Nylons (1976) and Clough Mill (1985).
Personal Guarantees (PGs) became an increasingly common tool to concentrate the minds of directors, many cases involving banks reached the courts. PGs were particularly visible in the construction sector, where builders merchants embedded PGs in their terms and conditions.
In recognition of the savaging effects of bad debts, the late 1990s finally saw new rules on the statue book. The late Payment of Commercial Debts (Interest) Act 1998, ushering in three stages: the right to claim interest from large businesses and public sector organisations; this was extended to allow small businesses to claim interest from other small businesses; finally, the right to claim interest to all businesses and public sector organisations, regardless of size.
What are the risks businesses face when offering credit – and how do directors protect themselves from late payers?
Late and Non-Payment are the major cause of business failure; roughly between 47% to 55% of all B2B invoices are paid late or not at all.
Businesses typically use these forms of protection
- Risk Management Tools: To protect against bad debt, businesses utilise trade credit insurance which can reimburse up to 95% of unpaid invoices. In my time I have acted variously for Trade Indemnity, Euler Hermes, Atradius and others and it was apparent that many industrial sectors could not function without credit insurance in place. The more commercially minded credit manager traded beyond the insured credit limit but this required constant monitoring.
- Alternatives: Many firms now use digital B2B Buy Now, Pay Later (BNPL) providers including Kriya and Mondu to offer credit terms without carrying the financial risk on their own balance sheets.
How should businesses assess creditworthiness to avoid bad debt and possible insolvency?
- Character: The customer’s reputation and track record. Trade references are still common in many sectors. What is the business history?
- Capacity: The ability to generate enough cash flow to pay the debt. Credit teams look at revenue streams and debt-to-income (DTI) ratios (ideally below 36%).
- Capital: The business’s overall financial strength, its net worth and retained earnings.
- Collateral: Assets (inventory, equipment, property) that could be liquidated to settle the debt if cash flow fails.
- Conditions: External factors like the economic climate, industry trends, or geographical risks that might impact the buyer’s stability.
What practical checks can suppliers use to protect themselves from unpaid invoices?
The main ones are:
- Business Credit Reports: Agencies like Experian, Dun & Bradstreet and Equifax provide scores (typically 1–100) that predict the likelihood of default. A score above 75–80 is generally considered low risk.
- Trade References: Requesting references from the buyer’s other suppliers can reveal real-world payment habits that credit scores might miss. Credit scores are heavily weighted to filed accounts because many trading businesses are reluctant to report to a credit agency their payment history.
- Financial Statement Analysis: Reviewing filed accounts to calculate key liquidity ratios:
- Current Ratio: Current Assets ÷ Current Liabilities (1:1 is common; 2:1 is traditionally seen as very safe).
- Quick Ratio (Acid Test): (Cash + Receivables) ÷ Current Liabilities. A ratio below 1:1 suggests the company may struggle to meet immediate obligations.
- Public Records: “Red Flags” such as County Court Judgments (CCJs), insolvency filings, or a history of late statutory filings.
How can suppliers reduce risk when a customer’s creditworthiness is uncertain?
- Pro-forma Invoicing: Requiring full or partial payment upfront for the first few orders to build trust.
- Small Limits: Setting a modest credit limit that can be increased once a compliant payment history is established.
- Trade Credit Insurance: Using a credit insurer to vet the customer and guarantee payment if they default.
How can Antony Batty & Co help?
By assessing the underlying business, stabilising cash flow, negotiating with creditors and implementing restructuring solutions before the situation becomes irreversible. Where rescue measures are not appropriate, we will act quickly to place the company into liquidation, Administration or assess the viability of a CVA.
Restructuring and turnaround services include:
- Conduct a thorough analysis of your financial statements and cash flow
- Develop a realistic financial forecast
- Recommend (and help you implement, if required) an actionable plan to improve your cash flow and reduce costs
- Help you to negotiate with creditors to reduce your debts and improve your financial position
If your business is facing credit issues, or indeed any type of financial pressure, talk to our Partners for help and advice.
The initial discussion is free of charge and in complete confidence
FAQs – trade credit, bad debt and insolvency – what do directors need to know?
How does trade credit lead to insolvency?
When customers pay late or not at all, SMEs lose both turnover and profit. This creates cashflow pressure, creditor arrears and an increased risk of insolvency.
What are the early warning signs of a credit-driven cashflow problem?
Slower payments, reduced orders, CCJs, overdue filings, requests for extended terms, or reliance on new sales to pay old debts.
How can I protect my business from bad debt?
Use credit reports, trade references, credit insurance, proforma invoicing, small initial limits and regular monitoring.
What should I do if unpaid invoices are creating cashflow pressure?
Act early. Seek advice before suppliers pull credit or arrears escalate. Early restructuring preserves options: late action reduces them.
How can Antony Batty & Co help with trade credit and insolvency?
By assessing the underlying business, stabilising cash flow, negotiating with creditors and implementing restructuring solutions before the situation becomes irreversible. Where rescue measures are not appropriate, we will act quickly to place the company into liquidation, Administration or assess viability of CVA.
