Begbies Traynor: Bad debt poses a substantial risk to a business, particularly if there are underlying reasons that aren’t addressed effectively. Bad debts negatively affect cash flow, as the expected sums aren’t received and cash shortfalls typically occur as a result.

Unfortunately, this impacts the company’s ability to operate at optimum levels. It can also restrict growth, but most worryingly, a threat of insolvency emerges when running a company with consistently high bad debt levels. The day-to-day reality of incurring bad debts can include, but is not limited to:

  • Lack of working capital to pay the bills and other liabilities
  • A poor reputation in the market, but also amongst staff and other stakeholders
  • Compromised growth
  • Irreversible financial distress

What is a bad debt?

A bad debt is money that’s owed to a business but isn’t paid. It’s a debt that isn’t going to be recovered and that has to be written off in the company’s accounts. It represents a financial loss for a business and if a large number of bad debts are incurred, they can pose a serious risk of consistent financial decline.
It’s possible to minimise the chances of this happening, however, and regain control of debt collection via a series of tried and trusted measures. So how does a business lower its likelihood of bad debts?

How to reduce bad debts in business

  • Credit checking customers

Obtaining reliable credit risk reports guides company directors away from new customers who pose a risk of late or non-payment. These reports are also valuable when determining whether current customers are experiencing financial problems that could affect the business.

  • Using credit insurance

Taking out a credit insurance policy can alleviate some of the concerns over bad debts as it covers financial losses associated with unpaid invoices. A policy may cover a proportion of an outstanding debt, or the entire sum, and may also insure against some or all of the legal costs of chasing a debt.

  • Offering early payment discounts

Offering a discount for paying an invoice early – perhaps within seven days – incentivises customers to pay quickly and can significantly improve a company’s cash flow. It helps to minimise the risk of incurring bad debt and facilitates regular cash inputs.

  • Clearly stating terms of payment

Laying out clear payment terms on all invoices, and checking in with a customer to ensure they’re happy with the product or service, leaves little room for delaying tactics that sometimes lead to a bad debt. Terms should include how much the customer owes, how long they have to pay, and the interest and/or fees that will be applied for late payment.

  • Invoicing early

Invoicing as soon as a product has been delivered or a service provided encourages early payment and can reduce the likelihood of a bad debt occurring because the customer’s obligation to pay is fresh in their mind.

  • Invoice factoring

Invoice factoring is a form of borrowing that releases a large proportion of an unpaid invoice, usually within 24-48 hours of issue. The lender may also take control of the company’s credit control function, and this can be hugely beneficial for businesses that struggle to collect their debts efficiently.

  • Being strategic to improve debt collection results

It’s impossible to avoid bad debts altogether in business but incurring multiple bad debts is worrying for business owners. That’s why developing a strong and cohesive system of debt recovery is worthwhile and supports business growth. This doesn’t need to be complex, however – a straightforward process that’s followed consistently reduces the likelihood of adverse cash flows that can lead to insolvency and minimises disruption on an operational level

Article written by Chris Lawton, Partner at Begbies Traynor Group Preston. Chris has worked in the insolvency sector since 2007, dealing with Creditors’ Voluntary Liquidations, Administrations, Company Voluntary Arrangements and Members’ Voluntary Liquidations in the main, working alongside company directors in order to find the appropriate insolvency process to deal with a company’s financial position.

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Published On: June 13th, 2024