Bad Debts affect all businesses. Your business might have some key customers who make up a large proportion of your annual turnover. Could your business survive if one key customer went bust?
This is why it is important to consider the credit control practices in your business. Credit control is more than just keeping an eye on bad debts and chasing payment. It’s about staff being aware of the warning signs which can indicate one of your customers is struggling to meet its financial commitments. This could lead to bad debts damaging your business.
Bad Debts: How do they happen?
A business going under usually comes after a period of decline for the business. It rarely happens overnight. The general phases are:
- The business’ turnover declines. This could be due to a fall in interest for its products or services. It could also be because of an increase in competition from other businesses here and abroad.
- A reduction in cash into the business means it cannot invest or diversify into other areas/industries. It focuses its cash on trying to weather the immediate storm hoping its fortune will change for the better.
- If the cash position of the business does not improve it will begin to show signs of being unable to pay suppliers and staff on time, or at all. It starts to build up bad debts. Eventually the business will stop trading.
Unless the business does something to stop this decline the options available to it reduce. The likelihood of bad debts increase.
Bad Debts: What are the Signs?
What can you do to try and spot signs a customer might leave you with a bad debt?
- Reputation decline. This can often be the beginning of the end. Has the customer undergone reputational damage? Perhaps it has been fined or prosecuted recently? Is the customer part of an industry or sector which is slowing down? Are its products or services old fashioned? Is there better technology available or cheaper competitors?
- Falling gross profit. If you trade regularly with key customers it is sensible to keep an eye on their financial stability. There are lots of credit control tools available which help you watch key customers’ financial performance. Gross profit is a general indicator of business performance.
- Rebranding or new projects. Is your customer launching a rebrand or new products/projects. This could suggest they are doing very well for themselves but it could also be a sticking plaster to mask bigger problems. If they are investing a lot of capital into new projects consider how this spending will impact upon their day to day cash flow. Bad debts could follow if they over spend.
- Staff moral. The early warning signs usually come from within a company. If there is a high turnover of staff this could indicate problems within the business. Your staff should be encouraged to share rumors or reports about your customers.
- Changes to payment terms. An obvious sign is a good paying customer now taking a long time to pay. This should ring alarm bells. You should consider if you want to continue trading with this customer under these conditions. You may start to see bad debts with this customer.
Bad Debts: What can I do?
By paying closer attention to your customers’ whole business you can pick up important indications and signs of financial distress. These could mean bad debts to follow.
With this information you can decide how best to address the issue with the customer. Options include:
- Stop trading with the customer. This is the easiest way to avoid bad debts.
- Ask for payment ‘up front’
- Limit your potential for bad debts. You could shortening payment terms. You could reduce credit terms.
- You can ask the directors to give you personal guarantees. If the directors of a company will not give you a personal guarantee and they cannot trade on immediate payment terms this is a strong warning that bad debts may follow. If the directors do not have faith in their own company to pay you it means you probably won’t be paid.
- Chase your bad debts. Put pressure on them to pay you. Phone calls work best.
- Send letters requesting payment.
- Consider a lawyer’s letter demanding payment of your bad debts.
- Quick legal action can get you paid before the business goes under. Get in first.
For more information please contact Susan Lewis for more information on how Jordan’s Solicitors can help you with your bad debts.