There is a famous quote that says: “A business can go broke while making a profit.” If this were to happen to your business, it would indicate poor cash-flows. Cash-flow is vital to every business as it reflects your ability to pay day-to-day expenses so without strong cash-flows, you could find yourself in a bit of trouble. One of the largest obstacles to solid cash-flow is bad debt, as reflected in your accounts receivable. The longer a client lingers in accounts receivable, the more likely they are to turn into bad debt and this has a massive effect on your liquidity. A build-up of these bad debts could lead to the demise of your business. This is why it is important to keep on top of your debtors before it is too late.
Avoiding Bad Debt
Here are a few strategies to help avoid bad debt.
- Clearly outline payment terms and consult a lawyer to work on your terms and conditions
Chasing debtors can be expensive and if your terms and conditions are not clear you may be exposed to these costs
- Provide clients with numerous payment options and make them easily accessible
Seek immediate payment options including PayPal Here card readers or the Apple Square Reader.
- Have a clear system and process for collecting debts
Do not try and create an ad hoc solution to debtors because this will quickly make things complicated.
- Stay on top of your debtors
Make sure you keep reminding debtors that they have money owed. If it is fresh on their mind, they will more likely pay. But be careful not to harass them.
- Be prepared to discuss alternatives
If your debtor is going through financial hardship, be prepared to offer options such as part-payments.
Dealing with bad debt
- The first thing to do is consult a lawyer to work out your terms in the event of a bad debt. Your client will likely cover this cost as it is a cost of debt collection.
- Provide a clear line of communication with the bad debtor and provide options for them to pay it down. Remember to be flexible; the more options you provide, the more likely the client is to pay.
- You should be reviewing your debtor exposure with your accountant regularly to see if one debtor takes up a large percentage of overall debt owed. We have seen clients going into administration because one client makes up too much of the overall debtor book so make sure you get on top of them.
- As a last resort, use a debt collection service to chase the debtor. It is best to have a relationship with a law firm who specialise in this area.
Collecting Bad Debt
- Have a clear system and process in place that explains, from start to finish, how you deal with a bad debtor.
- Consider insuring your debtor book if it makes up a large percentage of your balance sheet. If your debtor book takes, for example, 40% of your balance sheet then it is a large asset that can be insured.
- Make sure you have a signed copy of your engagement letter to provide to the debt collector if the need arises.
In the end, the most important aspect of debtors is prior planning. Develop your system and process first, then engage a lawyer to review your engagements. Review your debtor exposure regularly and use technology to bring down the cost of manual applications. If you need any advice, please do not hesitate to contact us.