Quantifying Creditors Days is possible but why not have them in the accounts?
The surest way of disturbing a nest of vipers is to thrash around in the undergrowth. Back in May, this column went nature spotting, seeking a form of wildlife still found - ophiologists believed - in parts of Britain, particularly in urban areas. This was Obligor tardus maximus, popularly known as Great Slow Payer.
There was a great interest in the creature on account of the damage it was said to cause. The Chancellor of the Exchequer (revealing a hitherto unsuspected concern for protection of the environment) outlined in his Budget speech measures that the Government had in mind for its control. The CBI also wanted to see the pest stamped out. The trouble was that, while any number of respectable citizens were prepared to testify that it had devastated their gardens and undermined their workshops, none could remember seeing it. For some reason, all the witnesses appeared hypnotised by the thing.
Well, we found Obligor. And, using a noval technique perfected by pioneering researcher Dennis Henry of V I Consultants, we identified individual specimens. (Essentially, the technique consists of shining a bright light on the creature's balance sheet and extracting certain pieces of information which are then fed into a computer - though it's so simple it can be used by anyone who knows how long division. See box). We confirmed that Obligor also tends to be particulary prelevent in certain industrial sectors, notably construction.
It has thus been possible to bring quantification to bear on what has long been a purely subjective debate - around grumbles and rumours and anecdotes about the delaying and bullying tactics employed by certain (unnamed) big companies towards their small suppliers. For example, Ron Davies, of the Federation of Associations of Specialist Subcontractors, tells of one of his members who was run up on a Thursday by a main contractor - who owned him a five figure sum - to be informed that he would not be paid a penny until he had signed a contract. Which sounds fine except that it ignores normal trade practice. The contract was then sent round, stamped on every page "No payment made until contract has been signed." The document contained onerous clauses that the subcontractor would have wished to negotiate over. (It's not unknown, incidentally, for a contract to deny a subcontractor the right to arbitration in the event of a dispute). He had the choice of signing or of continuing to wait for his money. In the construction industry, the subcontractor doesn't present an invoice of course. He's usually paid on the basis of a surveyor or architect's valuation of work carried out.
The revelation that it's possible to calculate, from published accounts, the length of time that a company takes to pay its trade creditors - not an actual figure, admittedly, but a perfectly valid indication - caused a small storm; especially as some of the slowest (and quickest) payers were named. Several of he designated slow payers wrote to us on aggrieved terms. Some of them had taken the trouble to analyse their figures in detail, others simply objected to being identified. Less surprisingly, none of the fast payers saw any reason for complaint.
But we should all give credit where it's due. Quite a few of the com,panies in the slow category have since published more recent accounts, and several show a distinct turn for the better. Crest Nicholson, for example, revealed a spectacular drop in Creditor Days from 96 to 48 last year. Lilley, one of the groups which declared its support for the CBI's Prompt Payment Code, came down from 82 days to 68, AMEC dropped from 83 to 80, Lovell from 98 to 87. But the latest results of some companies show a deterioration.
Outside the construction industry, Weir Group, which has many long-term overseas contracts, improved from 80 days to 65, and Wace from 86 to 56. Wace wrote to use to point out a distortion in the earlier figure brought about by acquisitions.
The Rank Organisation similarly identified distortions caused by changes in the composition of the group, and by its very large income from Rank Xerox. Adjustment here would have brought Rank down from 92 days to 73, but the improvement in the 1991 accounts is even more striking at 47 days, which is in the area where Rank believed it lay.
Crest Nicholson drew our attention to a further possible source of misunderstanding. The company's Creditors figure includes liabilities for land purchases, payment for which have been deferred by agreement with the vendors. It must be emphasised that only Trade Creditors due within one year were used in our calculation of Creditor Days. The general understanding is that Trade Creditors represents an amount due to suppliers of materials and services used in the normal course of trading.
Dennis Henry comments: "Two important points arise from this analysis. First, companies should be required to be more specific as to the actual contents of Trade Creditors if any item other than those relating to day-to-day trading is included. Second, it would be of great value if companies were required to state their average Creditor Days in the notes to their accounts, along with an explanation of any extended terms of trade that may have been negotiated. These two changes would make the accounts much more useful to suppliers." The Government should bear these suggestions in mind when the Finance Bill returns to this important subject.
How to work out Creditor Days from the balance sheet.
The number of days each company took to pay trade creditors was calculated as follows:
Trade Creditors x 365.
= Creditor Days.
Materials and bought-in-service x 1,175.
The Trade Creditors figures in company accounts usually represents current liabilities for materials and bought in services used in the normal course of trading and due for payment within one year. As the published figure could include VAT, the value was reduced in each case by dividing it by 1.175 to ensure that it was not overvalued.
The figure for materials and bought-in services was found by deducting Added Value from the sales figure. Added Value was reached by calculating the sum of employment costs, interest, tax, depreciation, minorities and retained profit where appropriate.
Source: Dennis Henry of VI Consultants.