Cash flow management has been a key focus area for small businesses over the past year, so the "Xero Small Business Insights (XSBI)" research program has done several deep-dive reports, including looking at the link between late payments and poor cash flow.
The latest XSBI research builds on these earlier reports and examines the relationship between late payments and how small businesses fund cash flow gaps that arise—that is, small business borrowings.
By combining the unique XSBI late payments data and Bank for International Settlements (BIS) non-financial corporation borrowing data, for the first time we are able to quantify what happens to small business borrowing when late payments increase.
Summary of XSBI Research Paper Digitalization and the adoption of payment technology are helping small businesses1 overcome many challenges related to late payment times. Although late payment times have been gradually reducing over time, XSBI data shows small businesses are still paid, on average, more than a week late.
This raises the question: How do small businesses fund the cash flow gap that arises due to late payments? One way to fund this gap would be through increased borrowings. But to date there have not been any empirical studies to establish a relationship between late payments and small business borrowing, due to the lack of data availability. This latest XSBI research addresses this gap.
The latest XSBI Research Paper, which includes full econometric analysis, features six main findings around the link between late payments and small business borrowing.
1. There is a statistically significant association between late payments and small business borrowing. That is, the data-based findings support the theory—as late payments rise, so does small business borrowing.2 Conversely, if small businesses are paid more quickly then small business borrowing would decline.
2. If late payments increase by one day, small businesses borrow 1.1% more in one quarter which corresponds to around US$278.7 billion. XSBI data provides a unique measure of late payments (the time delay between when an invoice is due and when it is actually paid) to small businesses in Australia, Canada, New Zealand, the UK and the US. Combining this data set with Bank for International Settlements data on small business borrowing allows for the actual measurement of this relationship in these markets.
The XSBI dataset used in the research was a combination of all late payment data from all five countries Xero covers with XSBI included. However, the research also did a partial analysis on data at the country-level and found that the late payments and borrowing relationship is largest for New Zealand, followed by the UK, the US and Australia and is smallest for Canada.
3. The effect of one additional day of late payment on small business borrowing is calculated to be around 5% of the average value of the total small business borrowing in a quarter. So how big is $278.7 billion extra in borrowing? Over the whole time period of this analysis (2017 to 2022) the average borrowing in a quarter for these five countries is $4418.2 billion (USD). That is, the extra borrowing ($278.7 billion) represents about 5% of average quarterly total borrowing between 2017 and 2022.
4. This relationship is non-linear and small business borrowing increased most when invoices were paid seven to eight days late. Just as there was some variation between countries, in the link between late payments and small business borrowing, the research also found differences depending on how late the payments were. The biggest impact on borrowing was when payments were seven to eight days late.
5. Small businesses borrowed from non-bank institutions when invoices were paid late. There are three main sources that small businesses could borrow from—households (i.e. borrow against personal assets), banks and non-banks. The research looked at all three of these options and found that non-banks are the main source of borrowing when invoices are paid late and a cash flow gap needs to be filled. Non-bank financial institutions tend to charge higher interest rates than banks, putting an additional cost impact of late payments on small businesses.
6. Small businesses borrowed more when interest rates went up and invoices were paid late. Given the current environment of central banks lifting interest rates, the research also looked at what happens to business borrowing when invoices are paid late and central banks are lifting rates. Not surprisingly, the data showed that this results in small businesses needing to borrow more to cover these late payments.
What does this mean for late payment policies and small businesses?
By quantifying the link between late payments and small business borrowing, this research has highlighted the cost that late payments impose on small businesses. Even if the invoices are eventually paid, late payments still have a cost because small businesses borrow in order to manage the cash flow problems arising from late payments, and they do so from a generally more costly source of funds (non-banks).
These findings highlight how important efforts are to reduce late payments to small businesses, whether this is through mandated policy changes from governments or behavioural changes from other businesses.
To help small businesses with their late payments and cash flow, Xero has developed a cash flow hub which features lots of tips and guides.
You can access more "Xero Small Business Insights" data and research HERE.
1. In this paper, small business refers to small- and medium-sized businesses.
2. There may be other causes which explain the relationship between late payments and increased borrowing. Our research confirms that this relationship exists, not that one causes the other.
Louise Southall is an economist at Xero. She joined the company in mid-2020 as part of the Xero Small Business Insights (XSBI) team. She has more than 25 years experience in economics and business advocacy working with multiple business organisations, councils, government agencies and charities. Her work has covered a broad range of economic and business-related policy issues, membership projects and thought-leadership research.
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