6 Ways to Prevent Bad Debt From Ruining Your Business

6 Ways to Prevent bad Debt

One of the most important aspects of running a small or medium-sized business is being able to ensure that you have a steady flow of income into the business every week, month or quarter.

Letting bad debt accumulate can seriously affect your business’s cash flow.

If your business, like hundreds of thousands of other small businesses, extends a line of credit to its customers, there’s always the possibility that the money you’re owed by a customer could go unpaid for months, or even entirely.

This type of debt is known as “bad debt”, and it’s something that every business – from a small sole trader to a large corporation – wants to avoid. When you let bad debt accumulate, the consequences for your business’s cash flow can be serious.

In fact, when a large amount of bad debt accumulates and your business isn’t able to collect from its customers, the impact on its cash flow has the potential to push your business into insolvency.

Avoiding bad debt is essential for operating your business smoothly. We spoke to the corporate insolvency experts at Corporate Recovery Help to learn six effective ways your business can prevent bad debts from ruining its finances.

Be selective about which customers receive a line of credit

Can you trust all of your customers to pay their bills on time? Most businesses run using credit to some extent, and you’ll generally attract more customers – and earn more income – if your business offers its customers a line of credit.

This could take the form of a certain limit on spending before bills are due, or even a weekly or monthly system where customers are billed at the end of a certain period – a popular option for service companies.

While offering a line of credit to customers will help your business grow, there are times when you’ll want to be selective about who should receive credit. Customers that have a history of payment issues may experience similar issues in the future.

Before you give a customer a credit line and let them purchase your product without immediately paying you, review their credit history (if available) and take a detailed look at their business to ensure they’re creditworthy.

A small amount of investigation and selectivity might lose you some accounts, but it also protects your business from extending credit to customers that aren’t likely to keep up with their payments.

Extend a customer’s credit line gradually as they pay you

As the old saying goes, the best predictor of future behaviour is past behaviour. If a customer has been purchasing your product or service for several years and always paid their bills on time, extending their credit line is a relatively low-risk decision.

A good way to limit your company’s potential exposure to bad debt is to gradually increase the amount of credit you offer customers. Start with a small account size that provides reasonable flexibility and let it grow slowly as customers pay you.

Although this technique doesn’t completely protect your business from bad debts – almost no strategy offers 100% protection – it ensures you only extend large levels of credit to customers that have previously proven they’re capable of repaying it.

The longer a debt goes unpaid, the less likely it is to be paid

Has one of your business’s invoices gone unpaid for several weeks? When an invoice becomes overdue and a debt becomes less certain than it previously was, it’s vital to take action in order to recover it as quickly as possible.

The longer a debt goes unpaid, the less likely it is to be paid at all. If your customer is ignoring an overdue debt, there’s a good possibility that they’ll “move on” and forget about it completely unless you take action.

Follow up with customers that don’t pay on time within days of non-payment. As the weeks go by, send payment notices to the customer to inform them that they haven’t paid their bill and keep in close contact to ensure they remain aware of the debt.

Charge late fees for customers that frequently don’t pay on time

One of the most important aspects of operating a business is maintaining steady and predictable cash flow. If several of your customers fail to pay on time, it can squeeze your business’s cash reserves and bring its operations to a standstill.

A great way to ensure your company is paid on time is to charge a late fee to clients and customers that pay behind schedule. A late fee of 10% is often enough to hurt a customer’s profit margin on your product or service and ensure they pay quickly.

It’s important not to be too aggressive with late fees – an astronomical late fee will send a bad message to your customers and make your business look like a bully. A late fee of 5-10% of the total account balance is enough to encourage action.

Offer a discount for customers that pay their invoices early

If charging customers a late fee doesn’t appeal to you, then a more effective way to ensure debts to your business don’t go bad is by offering a discount for customers that pay your business ahead of time.

Just like a 5-10% late fee can discourage late payment, a 5-10% discount for early payment will encourage your business’s customers to set aside sufficient cash for your company’s invoices and pay you ahead of schedule.

If you’re priced your product or service correctly, a small reduction in its cost for customers that pay early shouldn’t affect earnings significantly. In many cases, the cost of an early payment discount is far lower than the cost of writing off bad debt.

When debts go unpaid, speak to your lawyer immediately

As we mentioned earlier, debts that go unpaid for long periods of time are unlikely to be paid at all. Because of this, it’s important to send a strong, clear message to a non-paying customer as soon as their debt becomes doubtful.

If your business is owed a significant amount of money by a customer that doesn’t seem to be interested in paying, speak with your lawyer and have them prepare a letter clearly explaining that you require timely payment of their debt.

Companies that are experiencing financial issues or simply uninterested in paying will often ignore warnings that come from your company, but will be forced to pay attention if they’re issued with a statutory payment demand from your lawyer.

If bad debt is affecting your business, talk to us about turnaround finance today.

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