A recent survey of 761 small businesses undertaken by the Commonwealth Bank of Australia (ASX: CBA), has highlighted the significant proportion of overdue debts held by small business, which the bank believes is creating a 'domino effect' on other companies.
Whilst these businesses are carrying a total of $10.4 billion of debt – 62% of which is overdue – one of the key findings of the survey was that the average business is owed $18,624. Of the businesses surveyed, 29% stated that they withhold payments in order to preserve their own cash holdings.
Adam Bennett, the general manager of local business banking at CBA, recognises that a lot of business owners do a good job of managing their finances, however, there are a large proportion of businesses where it is not a core skill. According to Bennett, these companies are "more likely to find themselves in a difficult position", and should be encouraged to seek assistance early rather than making late payments.
The Debts:
Companies that are often affected by overdue debts are telecommunications companies or loan companies, such as Cash Converters (ASX: CCV), FlexiGroup (ASX:FXL) and Silver Chef (ASX: SIV).
Cash Converters, for instance, is a retailer of second-hand goods and provider of secured and unsecured loans. Whilst the company managed to increase its bad debt recovery level by 25% to $2.05 million, its level of bad debt also grew substantially in the 2012 financial year, with $26.125 million in bad debts recognised compared to $12.418 million in 2011.
The opportunities:
When faced with bad debts, many companies are now outsourcing the task of collecting on those debts to corporations such as Collection House (ASX: CLH) and Credit Corp Group (ASX: CCP). These companies have given investors enormous gains over the last 12 months, as demand for their services continues to soar.
Whilst offering a wide array of receivables services, the key money-maker for both companies is in 'Purchased Debt Ledgers' (PDL's), whereby the company buys debts from other creditors and profits heavily on each of the accounts recovered.
As more and more companies (and individuals, for that matter) find themselves with overdue debts, investors are recognising the opportunity for these companies to benefit greatly in the future. Shares in Collection House, for instance, climbed from 80c 12 months ago to as high as $1.74. Whilst the market has largely retracted over the last month, a fantastic buying opportunity has presented itself, with shares now trading at just over $1.40.
Foolish Takeaway:
In order to realise market-beating gains, it is often necessary to seek out well run companies where the majority of other investors are not looking. Although bad debts do not play favourably for most corporations, the growing level of overdue debts should prove to be very beneficial for Collection House and Credit Corp.
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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned in this article.
