The "Two-Feet-Deep" Danger

We’ve all heard the one about a man (hopefully a statistician) drowning in a river that is, on average, only two feet deep.

It’s not that the information about average depth is either inaccurate or unimportant. It’s just that it’s not ENOUGH information if you happen to be crossing at the wrong point.

In my last post I said that I’d write next about the 2nd quarter figures in the “National Summary of Domestic Trade Receivables” published by the Credit Research Foundation. The CRF has published this survey quarterly for 50 years.

I’ll only make broad comments because the material is copyrighted. See www.crfonline.org for subscription information and other products and services offered.

The CRF has devised and publishes a “Collection Effectiveness Index”, which is a single-figure indicator of the general health of the domestic trade receivables market.

That measure showed a significant improvement in 2Q-2010 compared to 1Q and a small improvement over the year-ago period. Most other aggregate measures they report showed similar improvements:

a) decreasing days-sales-outstanding,

b) decreasing delinquencies,

c) increasing percentage of accounts current, and

d) decreasing percentage of accounts over 91 days past due.

These high-level, market-wide measures are useful indicators that nevertheless have to be understood in the context of potential lag-effect, bias from sample size and bias from self-reporting.

The breakdown provided by industry group can be more valuable since it reveals substantial variances from the reported medians.

For example, in the category of “% Current” the range among industries in 2Q-2010 was from 39.13% to 94.76%.

Of particular interest to me as I studied the results was the disconnect between the improving picture painted in the CRF report and the anecdotal information that I’ve been hearing recently from clients and others. The message I’m hearing is that there has been a continued deterioration in the ability to collect money owed to small and mid-sized businesses.

I’ve written in prior posts about an organized and concerted movement by Wall Street houses to educate large, credit-worthy businesses on the virtue of substantially lengthening payment terms to their suppliers and then offering to accelerate payments at a discount.

This “squeeze the little guy” campaign demonstrates a cynical disregard for the long-term damage to the SMB community, which is so important a source of job creation. Its openly-stated purpose is to leverage the large companies’ access to cheap capital as a tool to force suppliers to reduce effective prices.

Let me add a few, admittedly anecdotal, data points from conversations I’ve had in just the past week:

1. A colleague told me the other day that he had knowledge that a large, multi-national company had instituted a new, purposely-draconian, “reject the invoice” policy. The AP staff of this company will now reject any invoice for ANY deviance from its increasingly complex and difficult-to-understand invoicing policy; requiring a revision and re-submission. And, of course, stringing out the time to payment.

2. A client told me this week that one of their customers; an architectural firm that had done a substantial amount of work for a large public hospital; had had to fight for over 120 days to get a check, which then bounced.

3. A colleague reported that a large, national customer recently notified a certain class of supplier that it suspected that there had been fraud on the part of some of those suppliers and so had put a freeze on ALL payments to ALL suppliers in that category until an audit could be completed. Completion of the audit is not expected until YEAR-END!

4. A professional services firm that has been in business since 1914 has had to enter into a workout payment arrangement with a subcontractor on some UNDISPUTED bills to a large municipal school construction agency that have been unpaid for nearly a YEAR.

5. A painting contractor that has been doing a significant volume of work for one of the largest residential property management firms in the area for over 20 years now has about 75% of its receivables at over 90 days.

These are just a few items that have come up in the past week.

It’s certainly possible that my experience reflects a regional bias. It’s possible that the lag effect is a partial explanation. It’s also possible that it reflects a bias toward the kind of client I typically deal with in my spot-factoring business.

But the anecdotal reports that I’ve been getting certainly paint a picture that is at variance with that of the 2Q CRF report.

I do not question the CRF results. I think that the information they compile and analyze is valuable and important and I’d recommend it to anyone interested in top-line industry trends. It might well be that the next quarterly report will show the sort of softening that current anecdotal information hints at.

What I do suggest is that the need for liquidity in the SMB market and, specifically, for acceleration of receivable collections in that market, continues to be among the top two or three problems facing business owners.

And that’s good for prospecting by the TRE Seller-marketing group.

The Ariba Distinction

In our last post we addressed recent changes to the TRE invoice verification procedures. Two thoughtful and important comments have been posted in response and I’d call your attention to both.

The second of those comments, by Drew Hofler of The Ariba Supplier Network, highlights an issue that will (I hope) become increasingly important to all TRE Buyers.

Because a Seller that belongs to The Ariba Network brings added value to the table.

First of all--what is Ariba?

Quoting here from a press release:

“The Ariba Supplier Network is the world’s leading business collaboration platform, which combines technology and services to better match buyers and suppliers, automate transactions and optimize payments. Buyers and suppliers in 115 countries leverage the network to engage in transactions worth more than $110 billion a year and process one purchase order every two seconds. Leveraging the reputation and power of the Ariba Network, suppliers can lower the cost, risk and time associated with accessing capital.”

So, for our purposes, Ariba represents a VERY substantial volume of B2B receivables-creation, with a payment process that incorporates an automated, controlled, protected, invoice approval process.

Ariba and TRE have had a strategic alliance for some time now but the volume of Ariba invoices offered for sale on TRE has been minimal. That might be because of a lack of Ariba member education. It might be because the actual mechanics of uploading member invoices has not been as user-friendly as it might be.

In any event, Drew posted welcome news yesterday that I’d like to make sure to highlight. I quote from his comment to yesterday’s post…..

“This issue brings to light even more the value of invoices that are uploaded to the TRE platform directly from a supplier network such as Ariba. In the case of an Ariba supplier selling an invoice processed via the Ariba Network, both the issue brought up in the blog (verification) and the issue in the comment (quality of invoices/errors) are rendered moot.

1) Verification: When the next release of the Ariba Network (AN) comes out (4Q09), Ariba suppliers will be able to click a button and directly upload their approved invoices for sale to the TRE platform. Approved invoices are delivered directly to the AN from the Obligor's ERP, and are then transmitted directly to the TRE platform with no opportunity for the supplier to change any of the data contained within. Given the unbroken electronic chain of data, the need for verification is obviated.

2) Quality of Invoices & subsequent error correction: The nature of the Ariba Network is such that buyers/obligors set parameters up front that suppliers must meet in order for a submitted invoice to be considered in good order. This systematic quality control ensures that the vast majority of quality issues are filtered out before an invoice is even received by the Buyer/Obligor. So the issues brought up by Mr. Schmidt are largely removed for Ariba invoices.

Combine the above with the fact that eInvoicing via Ariba reduces invoice approval times down to an average of less than 5 days, and invoices sold by Ariba suppliers directly from the Ariba Network will offer TRE Buyers a qualitatively better option to reduce risk and extend returns.”

The critical issue to highlight in Drew’s comment, I believe, is that the Ariba system will actually provide a MORE robust verification process than had been offered by TRE even BEFORE its recent changes.

If I understand the mechanics of the network correctly—and I invite Drew to correct me or to amplify here—the invoices posted by an Ariba Seller will not only have been verified with respect to authenticity i.e. that there IS an invoice matching the Seller’s posting in the Account Debtor’s AP system, but the Account Debtor will have ACKNOWLEDGED that the goods provided have met the conditions of the agreement AND that the amount of the invoice is payable as and when indicated.

This provides a significant level of additional security to a TRE Buyer, which should result in preferential pricing of invoices originated by Ariba members.

A substantial increase in Ariba Seller activity would be a very good thing for TRE and, I suspect, for Ariba also. Let’s hope all interested parties work hard to make that happen!

Beware the Passage of Time

St. Augustine said: “Lord give me virtue -- but not yet.”

Augustine wasn’t talking about money, but the point is the same. Getting paid is a virtue. We want it-- but all in good time.

I’ve commented before on the perils of rapid repayment. I have to comment one more time. I just can’t help myself.

Included among the data provided by The Receivables Exchange on each Seller/Account Debtor relationship is a record of the Account Debtor’s payment velocity.

I personally think that TRE should report the figures on an “auction duration” basis; measured from the date of the sale of the Account Debtor’s invoice to the day that invoice is paid. That would tell the Buyers explicitly how long the funds used to buy the invoices were employed and it would tell the Seller's how much time they have "paid for".

But that is NOT what is provided and it is important to know that.

What IS provided is a record of the number of days from the DATE of the invoice to the date payment reaches the TRE lockbox. High, low and average figures are given.

So, in order to make an informed bid a Buyer needs to consider not just the payment history provided but also the age of the invoice at the time of purchase. Unless the payment history provided is analyzed in light of the current age of the invoice posted it can lead to unexpected results.

Let’s use an actual example:

A certain Account Debtor has a record of paying a certain Seller’s invoices in an average of 20 days. That is, 20 days from the date of the invoice.

That Seller posts a new auction. The invoice posted is 17 days old on the day of the posting. This invoice does not sell on the day of posting. In fact, three days later it still has not sold.

What is the position of a Buyer looking at that auction on the 20th day from the invoice date?

Based only on the history provided the answer is that he’s looking at a purchase with an expected duration of about ZERO days! The check could actually be hitting the lock box even as the payment for the invoice is being swept from the Buyer’s account.

In such a case what does the Buyer get?

He gets to pay the fixed exchange and transaction fees incurred in closing a purchase without earning anything at all. He gets to lose money on a deal that has been paid as agreed!

OK, so we have to be fair. The record shows that some payments have taken longer than 20 days to come in. So it’s possible that the Buyer will earn some revenue for his trouble. But, based on the record, it’s far from certain that he will earn enough to break even.

It’s also possible that the Seller knows something about the likely payment period of that specific invoice. Otherwise, why would he be willing to pay the Seller’s fees and transaction costs? He should hold that invoice and post a newer one for sale if he needs cash.

It’s also possible that the Seller has simply made an error and didn’t realize the implication of posting that particular invoice for sale. As a Buyer who has made errors while getting to know this new platform, I could both understand and sympathize.

It's also true that I don't know of an actual case in which the costs and fees of a transaction exceeded its revenue.

But the point still stands.

Taking the time to look at and understand the documentation supporting an auction is important and it’s clear that many auctions are completed without that being done.

As it happens, the auction described above sold on the 4th day after posting, or the 21st day after the date of the invoice. I considered making a bid calculated at the monthly discount rate necessary to break even on a one-day holding period but decided against it. Nobody likes a wiseguy!

The Perversity of Promptness

I’ve been buying receivables on The Receivable Exchange for several months now and I suspect that, in terms of the number of transactions, I’ve bought more than my fair share over that period.

A significant percentage of the auctions I’ve purchased have been closed-out: paid as agreed without problem. Those that remain open currently show no signs of problems: they appear to be running their natural course from purchase to close-out. And that’s, of course, a good thing.

During my time as an active Buyer I’ve learned a lot about the TRE Sellers and their Account Debtors, about the TRE platform and procedures and about the nuts-and-bolts mechanics of the buying, holding and close-out of transactions.

One of the things I had not anticipated is the promptness of some payments and the impact of that promptness on annualized transaction returns. The implications are significant and so I wanted to share the experience, at least in general terms (the TRE rules prevent my divulging actual transaction details).

However, since the result is a decision to refrain from bidding on some otherwise attractive receivables, I think the issue bears at least general discussion.

This issue arises because one of the fees charged to Buyers by TRE is a fixed percentage of the face amount of the receivables sold. The charge itself is a fraction of one percent and seems relatively insignificant; certainly not onerous. It’s impact becomes perverse only if payment is received very quickly.

For example: let’s consider the case of a single-invoice auction (or an auction of multiple invoices, all of which are paid at the same time). Let’s say that auction is paid off in 60 days. The impact of the up-front fixed fee is x times 360/60 in this case: or 6 times the fractional base. That will dilute the annualized return of the transaction, but not by an overly-significant amount.

On the other hand: let’s take a similar single-payment scenario when payment is received in 10 days. The initial fee impact in that case will be six times that of the case above. In other words the annualized return on the transaction will be diluted by 36 times the up-front fee, which now no longer looks so small!

What is the practical impact? Well, in my own case, I’m no longer willing to bid on the invoices of Account Debtors whose payments tend to come in very quickly. The dilution effect is just too substantial.

Now, it’s one thing to bid on an auction involving receivables due in 15 days, anticipating and aware of the likely dilution. It’s another to bid on an auction involving invoices payable in, say, sixty days and have them paid off in 10 days! That’s where the true perversity is felt!

Anomalies can always occur. Payments can be early or late for many reasons, some completely unpredictable.

But the TRE platform does provide Buyers the ability to research the past payment-velocity of each Account Debtor. Based on my own experience, Buyers should certainly take advantage of the opportunity to examine that history and take into account the probable velocity of payment receipt before bidding.

Bidding very aggressively on an auction that gets closed-out in just a few days is likely to lead to buyer’s remorse when the actual return on the closed deal is calculated!









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