Intercompany Indebtedness — A Problem for Bulgarian Economy

The article considersintercompany indebtedness in Bulgaria as a reason for blocking the working capital of the companies,needed for their operatingactivities.

The article examinesthe economic situation, unfavourable forbusiness, by using data from official sources of information and makes a comparative analysis of intercompany indebtednessyear by year.

It also suggestsways to protect companies against the risk of bad debts, as well as measures to address the already existing intercompany indebtedness.

Key terms: Bankruptcy, Situation of crisis, Non-financial sector, Intercompany indebtedness.

Introduction

Intercompany indebtedness in Bulgaria is the main obstacle to business development and is the major reason for the reduction in the prospects for investing in the country.

It leads to blocking the working capital of the company, the latter faced with the inability to perform its usual activities and to generate revenues and profits, which, in turn, leads to insolvency and certain bankruptcy.

Debts between companies are the result of the movement of the products of their labour and the raw materials for the manufacture of these products, or when the time of the physical transfer of goods (services, raw materials, etc.) is other than the time of making payment.

During the boom of the Bulgarian economy between 2006–2007, there were few outstanding debts. Their significant increase began in the early 2009, when the companies with default on payments increased by over 50 %. It was then that 1/5 of the companies claimed that this default was essential to their business. The data from October 2010 shows a slight drop in the group of companies with intercompany indebtedness. This is due not so much to a jump in the economy, as to the fact that in the times of crisis companies have become disciplined and have reduced their overdue positions.

The current recession in Bulgaria was brought in from without. Our economy is excessively open to the world economy and the sharp contraction in external demand led to a sharp decline in exports, in direct foreign investment and loans, and hence the import of goods and services, as most of it was precisely by foreign capital. The result was a general decrease in demand, that is there disappeared the buyers for part of the goods, produced by Bulgarian companies (because the actual demand was less than what was planned in the accounts of the producers in drawing up their budgets). In practice, the demand for some goods and services completely disappeared which led to the bankruptcy of the companies, producing these goods and services. In general, however, the reduced demand led to lower revenues for the companies, the result of unsold goods and higher levels of stocks in warehouses (the goods themselves, planned for sale but not sold), as compared to the period before the fall in demand.

An important aspect of such a study is the indebtedness by regions [2, р.502, 516]. In the Southeast region, in which Stara Zagora is located, 67 % of companies have intercompany indebtedness. Of the whole country in the best position in this respect is the Southwest region. No doubt the largest number of the companies with outstanding debt are the construction companies — about 90 %. Over 51 % of them have substantial overdue payments. Next come the companies in the furniture industry, logging and forestry.

According to statistics, every second company in Bulgaria has outstanding debt to another company. Indebtedness in the country continues to grow at a rapid pace and reflect on the direct production of companies and wages. Nearly 70 % of the transactions between Bulgarian companies are conducted with late payments and the terms of payment are significantly longer.

How does intercompany indebtedness fit into this picture of a crisis≤

Intercompany indebtedness in itself is not a particular problem. Normal intercompany indebtedness means that business is going, that there are relations between the companies that trust between them is growing. According to the data of the Bulgarian Industrial Association today intercompany indebtedness is within 190–200 billion BGN. The problem is with outstanding intercompany debts which, according to expert appraisal amount to 16–17 billion BGN.

There does not exist an accurate measure of intercompany indebtedness in Bulgaria. It is difficult to find one in the developed economies, too. Intercompany indebtedness is valuated by expert appraisal because the above mentioned billions are the result of the mechanical summing of the financial relations among companies. Thus they do not reflect the real intercompany indebtedness. Experts think this way: if in the Central Credit Register of the Bulgarian National Bank there are about 51 billion BGN, out of which 33 billion BGN are corporate debt to banks and credit institutions, the rough estimate of the sum outside the banks and the RTHETHEegister is the same, i.e. 33 billion BGN.

Assuming that half of them are outstanding, then around 16–17 billion BGN are overdue intercompany indebtedness.

If intercompany indebtedness in Bulgaria is on the increase, this means that in practice companies most often use mutual lending, taking on the risk of new future nonpayments. Thus they provide working capital until the time when the warehouses will be emptied of the accumulated unsold production, and that absolutely free — as the Bulgarian practice is of non-accrual of interest on commercial loans.

Thus, from a «problem», intercompany indebtedness or, rather, its increase, turns into a solution of the problem through the absence or the reduction of bank lending for operating needs. For intercompany indebtedness is practically a form of financing.

Of course, if the crisis continues to deepen, it will be increasingly difficult for companies to make payments to each other, which can ultimately lead to suspension of payments and bankruptcies. In times of crisis it is normal to have corporate bankruptcies, which means losses for all interested parties with reference to the company (those to whom it is indebted). However this would not be as a result of intercompany indebtedness, but of the crisis itself and of the shrinkage in demand.

Therefore, the increase in intercompany indebtedness not a factor for the recession, but the result of it.

There are two more facts that show the economic situation, unfavourable for business:

1.         The GDP — liabilities ratio [2, р.147]. For 2011 Bulgaria's GDP is 71.687 billion BGN which, correlated with the total debt of 163.1billion BGN shows an excess of over two times of debt over GDP. This is especially disturbing, as it means that the revenues with which we expect the debt to be repaid, are not sufficient and it can be expected that the debt will multiply.

By way of comparison, in the U. S. A., for example, corporate debt is approximately one to one with GDP — 95 %. In Europe corporate debt is on average 134 %, i.e. by 34 % more than GDP while company indebtedness in Bulgaria exceeds GDP two times.

2.         Percentage of outstanding debt. The increase in outstanding debt is another disturbing fact. On the one hand there is the outstanding debt to financial institutions. As at November 2012 its amount is already 25.8 % [4]. On the other, there is the outstanding debt to other companies and according to the data from a study of private bailiffs it becomes obvious that about 60 % of companies have defaulted on their payments. In plain language this means that every second company in Bulgaria does not settle its debts to counterparties within the agreed period.

For quite some time the National Statistical Institute has been studying the indicator «uncertain economic environment». This indicator is directly related to outstanding intercompany indebtedness. In October 2010 we saw a reduction in the number of companies with defaults in payment of under 50 %, which also reflects favourably on the indicator “uncertain economic environment” and it, in turn, influences significantly the process of attracting foreign investment.

Overall, the situation in the country is complicated because, in addition to the usual form of indebtedness, one entity indebted to another entity, there is chain indebtedness in which one entity, in order to meet its obligations to another entity, must obtain payment from a third entity.

In this situation it is hardly possible to quite accurately assess the amount of the total intercompany indebtedness, but according to the information in the National Statistical Institute [2, р.213] at the end of 2011 the total amount of the debt between the companies in the nonfinancial sector in Bulgaria is about 163 billion BGN, as compared to 157 billion BGN in 2010.

Over the last few years the intercompany indebtedness in the nonfinancial has been the following [1, р.32]:

-         for 2005–67 billion BGN;

-         for 2006–81 billion BGN;

-         for 2007–121.5 billion BGN;

-         for 2008–147.7 billion BGN;

-         for 2009–156.6 billion BGN;

-         for 2010–157.9 billion BGN;

-         for 2011–163.1 billion BGN;

The largest increase in one year was in 2007. and this is due to the steep increase in loans from financial institutions and the debts between related and associated companies. In 2009 however the increase in total debt, as compared to 2008, is due mainly to an increase in the payables to suppliers and the payables to related and associated companies

The analysis of recent years shows that there is a slight «easing» of the growth of debt since 2008. In 2010 it was the lowest — only 1.2 billion BGN more than 2009 This should not calm us because the general trend is for the indebtedness of non-financial sector companies to continue to grow. This is what was stated by the Bulgarian Industrial Association. In comparison with 2005 the volume of intercompany indebtedness has grown by 96 billion BGN.

Even more disturbing is the fact that in 2011 one BGN of GDP accounted for 2.27 BGN of debt. By way of comparison in 2005 one BGN of GDP accounted for 1.58 BGN of debt [4].

Although in the period 2005–2008 investment expenditures increased 2.2 times, from 2009 they began to decline. In 2011, though slightly, investment activity increased again, but in comparison with 2008 it decreased by about 40 %.

Access to bank loans remains difficult because of the uncertain economic environment. Interest rates on new loans registered a slight decrease from 10.7 % to 9.8 %, according to statistics.

The sales revenues of companies continue to grow more slowly than the debts of companies. In 2011 they were lower by 11 % as compared to the debts of companies. This means that manufacturing activity cannot provide sufficient funds for the payment of the debts of companies.

What should healthy companies do, who may be involved in the processes of indebtedness if they come across an incorrect counterparty≤

The main customers of Bulgarian companies are local customers. That is why it is important to know what their status and relation is. The West uses the so-called Registers of Outstanding Intercompany Receivables. They have existed in almost all developed economies for many years and have a strong database of information. They provide an opportunity for anyone who has some relations with their counterparties or is to enter into a relationship with such a counterparty to check whether this counterparty is correct in its financial dealings.

The debt management company EOS Matrix made a comparison between Bulgaria and some of the developed countries in Europe. It turned out that in Germany three times more companies check the solvency of their clients.

In Bulgaria only half of the companies make an effort in this direction. For a year now such an Internet register of overdue intercompany payables, Net Debt, is being made. It provides an opportunity for all the creditor companies who have overdue receivables to enter their debtors’ data and show them to the whole business community. This is a free register, which anyone can enter and see if there is any information on the relevant counterparty, to whom it has not been honest, how much it owes and for how long that amount has been outstanding. The register has several protections against false information. The main one is the signing of a declaration by the creditor company for the accuracy of the data that is obtained on paper, the signature and seal of the company are checked and only then is the data published and its progress is monitored.

There are a number of ways to protect companies[1] against the risk of bad debts. These include:

-          consultation with lawyers — the cooperation of professionals is a must, to provide all possible preventive measures in order to avoid the risk of occurrence of bad debts. Lawyers will ensure maximum protection for their client, clear communication and a clear policy in the negotiations for new deals and preparation of reliable contracts that contain specific terms, steps and actions for the collection of receivables;

-          reliable and quality contracts — ones considering the status of the relevant counterparty and drawn up by using appropriate tools for impact, depending on the capacities of the relevant counterparty, containing clauses to ensure maximum protection and making use of every opportunity, given by Bulgarian legislation to protect the company from future complications.

-          preliminary checks on potential counterparties — a detailed study of the financial status, supplying credit and property information, supplying information parties, related to the counterparty and the possibilities for future security.

-          securities — one of the reasons for intercompany indebtedness is the unsecured trust of the creditor in the debtor. This is a sign of very low legal and business culture. Besides, it is extremely dangerous. Providing securities for contracted loans/goods is a must, as well as ensuring specific payback dates.

-          collection of the receivables immediately after they fall due — despite the debtor’s promises for expected revenues and requests for rescheduling and deferral, waiting too long increases the risk of the specific receivable becoming uncollectible.. In the absence of voluntary payment, the credotor should resort to enforced payment through the courts. The procedure requires the intervention of a professional — a lawyer, and consists of issuing of a writ of execution by the competent court and the filing of an enforcement case with the bailiff. Proceedings may be initiated for interim relief before the relevant court.

-          the existence of a clear strategy and capacity for effective risk management — agroup of professionals to monitor the status of counterparties and the probability of an adequate collection of debt from them. They check the financial status of the relevant counterparty, prepare an analysis of his indebtedness, check for any outstanding debts and give an opinion on the degree of risk in concluding a deal with him.

How to deal with intercompany indebtedness≤

For this purpose it is necessary to review the current status of the counterparty, the information on him and on the basis of this analysis to decide on the appropriate action.

What information do you need and where can you get it from≤

 * Existing registers of debtors and ones in the making

-         http://www.debtnet.bg/ — private company with a register of intercompany debts;

-         https://www.registry.bcpea.org/ — register of private bailiffs, still in the making;

-         http://www.nap.bg/page≤id=137 — Register of the National Revenue Agency of debtors.

There are several steps for appropriate action and dealing with intercompany indebtedness:

1.                   Reassess the status of your counterparties and the probability to get back your receivables.

2.                   Classify debtors into several categories according to their status.

3.                   Select appropriate tools for impact on the respective group of counterparties.

4.                   Distribute tasks.

5.                   Monitor the results and change the approaches, if necessary.

6.                   Decide on preventive measures to keep the level of debts within a range that you can afford

Debt undermines the stability of the economy and, as a whole, delays the opportunities for economic growth in Bulgaria. The problem of bad debts must be resolved in the nearest future and the amount of accumulated debt be contained within reasonable limits.

From the macroeconomic point of view, the increase in intercompany indebtedness and the reduced access to financial resources makes the financial managers of companies use sources of funding within reasonable limits. This leads to a change in the behavior of companies in the public and private sector in order to adapt to the changing economic environment.

References:

1.       Andreeva, Donka. Company Financial Management and the Role of Business Valuation. Sofia, Publishing House of UNWE, 2012

2.       Statistical Yearbook of 2012. National Statistical Institute, Sofia, 2013.

3.       bg.bulgarianconsulting.eu

4.       www.slideshare.net/anialashka/2011