NAIROBI, 23 July, 2013 – Events of recent months have strained the financial capacity of many businesses and lenders. Consider a headline on a local newspaper on Mar. 25: “Freeze on tender payments strains traders’ cashflows”. While the freeze is temporary, unfortunately the problem of government payment delays is an ongoing one. Persistent challenges such as shortage of staff to process payments, diversion of funds to pay for priority items and bureaucracy often collude to ensure contractors and suppliers are not paid on time.
This has a significant impact on the economy. The government’s spending as a share of GDP stands at about 30%. Delayed payments could see the government paying higher prices for goods and services as suppliers seek to compensate for the opportunity costs.
Banks’ lending decisions are substantially based on the anticipated cash flows of borrowers. When these are interrupted, they have no other recourse than to mitigate the risk posed by the borrower by increasing the interest rate or denying the loan.
If a supplier borrows money from a bank to finance a contract and payment is not forthcoming, they will have difficulties servicing the debt. Although payments to suppliers and contractors will normalize after a while, the back-log of unpaid invoices extending to well over a year in some cases will take time to clear. Slow and tedious processing of payments is one of the challenges of doing business with public sector institutions.
There are however ways to navigate around these obstacles. Trade credit insurance, also called accounts receivable insurance can serve as added security. A trader can use the policy to cash-in up to 80% of the value of invoice if payment is delayed. You receive payment and then pay off the bank once the government pays up.
The main benefit of this solution is that the supplier does not have to bear the cost of interest and other fees that come with servicing a loan or overdraft for an extended period. It also frees cash for further contracts and investment.
Banks and other lenders can also use it in several ways. For example, it can help stem deterioration of a portfolio of clients who, in this instance may be contracting to the government. This approach protects the bank against non-payment or delayed payment risks.
Locally, only the African Trade Insurance Agency (ATI) provides the product along with international firms such as Atradius, Euler Hermes and Coface. The international firms tend to be less cost-effective due to lack of a local presence.
Another possible solution could be a bid, advance payment or performance bond, which offer protection at every stage of a project from inception, implementation and completion.
Bonds ensure that a contractor and a project owner stick to their part of the agreement and if one fails to uphold their end, then the other can obtain payment for work that has been completed according to the contract.
Bonds also act as a deterrent to contracting parties to conform to the rule of law regarding contracts by establishing a framework for a healthy contractual relationship. These guarantees can be obtained from insurance firms or banks. The question that many business people ask is: “why should I reduce my already slim profit margins for an expense that may not be necessary?”
The simple answer is that you don’t take out fire insurance when the fire is raging. This may require a change of mindset for companies long used to reacting to events rather than planning for them. The ability to control risk gives a business a unique competitive edge.
