How to Reduce Bad Debts in a Business

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The management of debt is fundamental to operating any business. Most businesses rely on different forms of credit; maybe they supply goods or services and invoice clients later, or offer payment plans to enable clients to afford more expensive products. Perhaps they rely on the credit terms offered by their own suppliers, to buy the things they need but not have to pay for them until they’ve raised cash from their customers. There are several advantages to good debts, provided they are managed successfully.

On the other hand, a bad debt is money that your business is owed that you are forced to write off. In other words, you must give up on chasing these debts because you know that you will not be able to get your money back. Some amount of bad debt is inevitable, but it is crucial for businesses to avoid it where they can and manage it where they cannot.

There are many reasons that a business might accrue bad debts, not all of which are the fault of the business owner; for example, if you extend credit to a customer with whom you have a good relationship, but they unexpectedly face problems of their own, this is difficult to anticipate and avoid.

At the same time, there are certain best practices you can employ to reduce your risk of incurring bad debts and ensure your business remains in the best possible financial position. Here, the experts at Company Insolvency Advice explain some of the key ways that businesses can avoid taking on bad debts and the financial consequences that stem from them. In this way, you can keep your company in the best possible financial position.

Credit Checks

Carrying out a credit assessment could be a vital way for businesses to manage risk, especially if there are areas of credit management in which they are falling short. There are a few ways that business’ credit policies can leave them vulnerable to the risk of bad debts, and starting by being proactive in this area can be a fruitful way to avoid writing off money that your organisation is owed.

The first thing to implement if you have not done so already is a policy of credit checks on any customer to which you intend to extend credit. This will give you key insights into your customer’s reliability and help you to assess the risk that they will not make their payments. A credit check will flag up areas of concern regarding past payment behaviour, such as defaults, bankruptcies and any existing debts that are as yet unpaid.

Remember that any credit relationship with another company introduces a degree of risk. Only by delving into a customer’s financial history will you be able to determine how much risk you are facing and implement strategies to mitigate this accordingly.

Credit limits

Once you have a strong understanding of the level of risk, you can set payment terms and credit limits. This is a good way to limit your exposure to high-risk customers, without having to be overly selective in the customers you work with. Once you have built a relationship with the customer and trust that they won’t default on payments, you may decide to adjust the credit limit you offer. However, in the early stages, you will be able to reduce the losses you would face if the customer defaulted on payment.

While these changes have a practical function, they may also have a positive psychological effect. When you begin working with a new customer and perform a credit check, or set a credit limit, this sends a clear message that your business monitors and controls credit. When customers know that they will be evaluated in this way (and recognise the consequences late payments and other issues could have on their credit score) they may be more inclined to pay on time.

Credit terms

It is important to set credit terms that will be easy to manage for your business. Avoiding bad debts is often about chasing payments, and it is important to have procedures in place that will allow you to do this without wasting resources. Often, small and emerging companies will offer very generous payment terms to customers as a way to attract business. This also helps them to delay the point at which they will have to be proactive in chasing up payment from the customer.

While this may be successful, it also heightens the risk of bad debts affecting your business’ finances. Strategies like shortening payment cycles and asking for upfront deposits are ways to mitigate this risk, and if you are concerned about how this will affect your business’ ability to grow, make sure to regularly review your policies and adapt them to make sure they continue to work for you.

A final consideration is to offer early payment discounts or incentives, or to impose penalties for late payments. This may be viewed unfavourably by some customers, but if your business has persistent problems in this area it may be a policy that is worth evaluating.

Other strategies

Ultimately, there are often options on the table for businesses that face financial difficulties, provided they act quickly and proactively. While the solutions we have described here are largely about avoiding bad debts, there are also ways that companies can deal with them when they arise, and help to mitigate their effects.

There are several such solutions that businesses might consider.

  • Diversifying your client base can help to offset the impact of bad debt. A company that relies on a few large customers is at much higher risk of suffering serious financial losses due to bad debt than a company with a higher number of smaller customers.
  • Depending on the size of the unpaid debts, it may be viable to hire a collection agency or other third party. While they will take a percentage of the recovered payment, this could be a vital way to keep your business from facing much more serious consequences.
  • Invoice factoring is another way to generate cash on unpaid invoices and outsource collection. In this process, you sell your invoices to a third party for a percentage of their value, and allow the factoring company to collect payment on your behalf. Once the invoices are paid, the finance company will send you the remaining value, minus a collection fee.
  • Consider implementing a dispute resolution policy. Sometimes, payment is held up because of a dispute with a customer, and having a process in place to resolve this can prevent you from reaching a stalemate.
  • Research credit insurance and determine whether a policy could help you. This can add an extra facet of security against the consequences of writing off a large debt, but you need to manage risk carefully in order to avoid paying high premiums.

If your business is facing financial difficulties as the result of bad debts, problems with cash flow or challenges related to customers, another option is to bring in an expert. The team at Company Insolvency Advice has many years of combined experience in resolving debt problems for businesses and helping them to move forwards to a place of recovery.

If you need support with financial challenges, contact us today. Call us on 0800 999 0666 or use our online enquiry form to request a call back at your convenience.

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Business Advice Expert

Robert Cooksey

Robert Cooksey

Director Advice Line: 0800 999 0666


Contact our team of company insolvency specialists

Company Insolvency Advice is a leading business rescue, corporate restructuring and insolvency specialists, with years of experience in providing corporate debt solutions. We understand the daily pressure you are under as a director and our team of expert consultants cover the whole of the country in order to discuss debt solutions with company directors.

The first port of call should be to consult with a licensed insolvency practitioner to discuss your options. Thankfully, you can arrange a free initial consultation with one of our local insolvency practitioners at your convenience.

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