Late payments can put SMEs at risk – these 9 steps can help protect your business

For SMEs, late payments can be more than just frustrating – they can create real cash flow challenges. According to the Federation of Small Businesses (FSB), every quarter in 2022, 52% of UK SMEs — roughly 2.8 million small firms — experienced at least one late payment.

The FSB has described this as one of the “biggest problems” facing small businesses, with delayed invoices often creating a domino effect that threatens their stability. When cash flow is disrupted, businesses can struggle to pay suppliers, staff, or other essential costs, leading to far-reaching consequences.

To mitigate this, a good first step is to sign up for the Fair Payment Code, which encourages businesses to commit to paying suppliers on time. There are clear guidelines for payment terms, and includes award categories (Gold, Silver, Bronze) to recognise businesses that pay suppliers quickly. By promoting fair payment practices, it’s hoped the code will help businesses avoid the negative impact of delayed payments.

Of course, overdue invoices are still a common challenge – but businesses can take steps to reduce their impact. By implementing proactive payment practices and utilising financial tools, SMEs can strengthen their cash flow and minimise the risks posed by late payments.

1. Set clear payment terms

Prevention starts with communication. Clear payment terms lay the groundwork for prompt payments and minimise disputes. Outline payment deadlines in contracts, and include late payment fees or interest clauses. For example, you can charge statutory interest on late payments, which is 8% plus the Bank of England base rate for business-to-business transactions.

If your business is owed £1,000 and the base rate is 0.5%, the annual statutory interest would be £85, equating to 23p per day. After 50 days, this would amount to £11.50. Ensure clients understand and agree to these terms before work begins, and issue a new invoice if you decide to apply interest. This upfront clarity not only protects your business legally but also sets expectations from day one.

2. Automate your invoicing process

Invoicing problems can sometimes cause late payments. Automating the process helps eliminate delays and ensures you send invoices promptly. Platforms like Xero, QuickBooks, or FreshBooks allow businesses to:

• Automatically generate and send invoices

• Track payment statuses in real-time

• Send polite payment reminders for overdue invoice

3. Build a cash reserve

A cash reserve provides a financial safety net, covering essential operating expenses for three to six months, helping your business navigate challenges like late payments or economic downturns. For example, during a recession, when consumer spending typically declines, a cash reserve can help your business maintain operations even if sales decrease.

Start by setting aside a small percentage of monthly revenue – over time, this buffer will grow and provide peace of mind during emergencies.

You can maximise your reserves by using business accounts. A business current account helps separate personal and business finances, streamlining cash flow management. Pair this with a business savings account to earn interest on your reserves, balancing accessibility with growth potential.

4. Explore financial tools and credit options

When cash flow issues arise, financial products can provide crucial support. Consider options like:

• Invoice financing: A service that advances funds against unpaid invoices, providing immediate cash while waiting for payments.

• Business credit cards: These can help cover short-term expenses and provide a convenient way to manage cash flow, offering flexibility in payments and potential rewards or benefits.

• Overdraft facilities: Many business bank accounts offer flexible overdrafts to bridge gaps in cash flow.

It’s worth evaluating and comparing these tools carefully to find what best suits your business needs.

5. Diversify your client base

Relying too heavily on a small number of clients increases your vulnerability. If one client delays payment or ends their contract, it could severely impact your business. Diversifying your client base can spread the risk across multiple revenue streams.

This might involve taking on smaller clients or exploring new markets. Diversification may not be immediately possible for small businesses with limited reach, but it’s worth considering as you grow.

6. Strengthen customer relationships

Clients are more likely to prioritise paying businesses they trust and value. Building strong relationships can make a significant difference:

• Communicate regularly with clients to maintain goodwill and identify potential payment issues early.

• Be understanding but firm when discussing overdue invoices. Offer payment plans for clients genuinely struggling, but remain clear about your boundaries.

A collaborative approach can resolve issues amicably and maintain long-term partnerships.

7. Get the right business insurance

The right insurance can protect your business against the financial impact of non-payment. Credit insurance, for example, can cover the value of unpaid invoices if a client fails to pay. This is especially useful for SMEs handling high-value contracts or working with international clients, where the risk of non-payment is higher.

While there’s a cost involved, having the right insurance in place provides peace of mind and ensures your business can continue to operate even if a client defaults.

8. Consider legal options

While legal action should be a last resort, it’s important to know your rights. UK businesses can charge interest and claim reasonable debt recovery costs on overdue invoices. For persistent late payers, you might decide to use a debt collection agency or pursue legal action through the courts.

Use these steps carefully to avoid damaging client relationships. Taking legal action can be costly and time-consuming, often taking months or even years to resolve.

In addition, pursuing a case could divert attention from running your business and strain resources. For these reasons, it's typically best to explore other avenues first, such as negotiating a payment plan or working with a collection agency.

9. Empower your team

Your team plays a key role in managing late payments. By being equipped with the right tools and knowledge, they’ll be able to handle these situations effectively.

Train staff to communicate payment terms clearly and follow up on overdue invoices professionally. Encourage collaboration between sales and finance teams to identify potential risks early.