Bad debt can significantly affect the operations of a business regardless of how successful it is. Debt and cash flow have a direct correlation and this why so many businesses particularly SMEs have cash flow as their main issue. If a business cannot manage cash flow effectively, it could easily cease operations. It’s not always that you will get paid immediately after supplying your products or service. Sometimes, you might not get paid at all. And that becomes bad debt.
It’s important to protect your business from bad debt to ensure cash is coming through. When it comes to bad debts, prevention is better than cure. But how? What should you do to minimize outstanding invoices or simply avoid debts? Well, in this blog you’ll learn the kind of systems and processes to implement to protect your business from bad debt. So, read on to learn more.
What is bad debt in your business?
Before we start talking about how to avoid bad debt in your business, it’s important to understand what it is.
Bad debt is the sum lost when one of your customers does not pay for the product or service provided. This sum should be written off in your books. Frequent or high levels of bad debt can significantly impact your business. Bad debts reduce the cash available to run your business on a daily basis and negatively affect your plans for business growth. Further, they will also affect your ability to pay your own creditors.
You can avoid debt by implementing certain systems or processes in your business.
Assess your customers’ creditworthiness
Prevention is better than cure. You need to know the type of customer that you choose to do business with. You need to choose your clients carefully, and this starts by assessing their creditworthiness. Your sales department should provide the ultimate profile of the perfect client to work with.
You can use credit reporting companies to conduct a financial health check for your clients. This should always be done in the onboarding stage as it gives a clear picture of whom you’re going into business with. You can also speak with past suppliers of the client and other industry colleagues to get a full picture.
Be sure to identify any red flags, especially in their financial department, and learn as much as possible about their financial health. Remember you want to get into business with a client who will not only pay for the products or services provided but also pay on time.
Have a money upfront policy
It’s important to have money upfront policy in your business. This policy sends a strong message to your clients that you’re serious about your products and payment. You should never be too scared to upset your customers by asking for money upfront. If you believe and value your products or services then make this your policy.
Additionally, upfront payments help lower the amount owing, thus in the event your client fails to pay the final amount, you’ll have recouped the majority of costs. It’s actually even better to ask your clients to make payments by milestone installments especially if your business relies heavily on regular cash flow.
Establish clear payment terms
Many companies out there are at risk of getting into frequent bad debts because they don’t have payment terms and those that have don’t follow them strictly. How do you expect to get paid if you don’t have clear payment terms in place?
You must set clear payment terms and explain them to your clients properly. Well set out payment terms serve as a clear understanding of the conditions that guide the relationship between your business and your clients, and most importantly protect your business.
The terms should make it clear that any costs associated with recovering outstanding invoices will be fully covered by the client. Make sure you have reiterated the payment terms in all the invoices so that clients have it on hand and avoid them paying on their own terms. Further, it’s important to have shorter credit terms to create a more immediate need for clients to pay for them.
Stick to your payment terms
Once you have set your payment terms, be sure to always stick to them. Sometimes, even when you’ve set out and explained your terms, some clients for one reason or another might fail to pay on time. So, what should you do? You should stop supplying clients who have failed to make payments on time. Well, this has a risk as it might cost you some business, but at the same time, it will help minimize the risk of getting into bad debt.
Also, you should stop supplying products or services to clients beyond their credit limit. You may increase the limit upon request, but until then this allows you to reassess the creditworthiness of your client before deciding to increase your debt exposure.
Additionally, if the payment terms outline that you’re going to charge penalties or interest for late payment, then stick to it. These charges should be made clear to your clients before adding them.
Offer incentives for early payments
It’s important to structure your payment terms in such a way that you can offer incentives for prompt payment. Incentives could be in the form of a small discount.
Getting into business with a client means you’re getting into a relationship with them, and like any other relationship in life, you should work on it. This is where following up comes in. Once you’ve made your payment terms clear you need to follow up to be in front of the mind of your customers.
Payments could be overdue for many reasons. Probably your client is in financial distress and would like to renegotiate terms, they forgot the payment was due, or they have had staffing change in accounts. So, getting in touch gives the whole picture, hence allowing you to resolve the situation in the best way possible.
Note that clients are more likely to give you higher priority than a business they haven’t heard from in a while. Many businesses that are paid on time, make the most “noise,” so, be sure to make “polite noise.”
Send invoices promptly
Be sure to send invoices on time to create the urgency of payment on your clients. Once the payments are overdue start actively chasing them. If you’ve been dealing with a particular client for a while, it’s important to be aware of their payment cycles. This helps you to identify the best time to send your invoice that coincides with their payment schedule.
If the payment is overdue get in touch with the client or use a professional such as a debt collection company to recover your payment effectively.
Properly document your transactions
Every transaction that you do with your customer should be properly documented. All the prices, quantities, payment terms and delivery dates should be documented. Avoid making verbal or sloppy orders as they present an opportunity for non-payment and disputes. You need to keep proofs all through.
Further, it’s important to have an accounting system that provides accurate information of the client that owes and the amount owing at a glance. You can find plenty of apps to choose from. They will help you keep your customers’ details and invoices up to date. Further, it becomes easier to identify the payment trends of clients.
Resolve disputes quickly
It’s crucial to resolve disputes quickly to be paid on time. Common disputes that may arise include an issue with your product or invoice, accounting or payment system glitch, or a customer experiencing financial distress.
Many times, a customer will use a dispute as an excuse for non-payment, therefore you must fix the dispute quickly to be paid. You might also need to reconsider the payment terms especially if your customer has failed to pay due to financial distress, which could be temporary or long-term.
Sometimes, you might need to involve professionals, especially if your attempts to recover the debt are unsuccessful. You can enlist the help of a debt collection company or a debt collection lawyer. A debt collection company is specialized in collecting debts in the most effective, efficient, and ethical way. What they charge for that can vary, some can charge a flat fee while others a percentage of the amount recovered. However, they should not be considered an expense but an investment.
Bad debts can significantly impact your business’ financial health and growth, some even end up ceasing operation. Therefore, it’s important to take appropriate steps to avoid bad debts. The above tips are simple procedures to implement to safeguard your business from bad debts and keep cash flowing.