Bad business debts and lack of sufficient cash flow can cripple a business.
As a business owner you should always be thinking about reducing bad business debts and getting those delinquent invoices paid.
This is even more vital in times of financial uncertainty such as before a recession or downturn.
This article will provide you with 30 tips to reduce your bad business debts and increase your cash flow in preparation for the uncertain financial future in Australia.
As the old saying goes, “prevention is better than cure”. Or the old proverb says, “it is better and more useful to meet a problem in time than to seek a remedy after the damage is done”.
In this complete guide our debt recovery solicitors will outline what you can do now to reduce bad debts in your business before incurring the debt, while the credit is active, and upon default.
But what is a bad business debt?
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What are Bad Business Debts?
A bad business debt is incurred when a business has provided goods and services to a customer / client, and that customer / client has not paid the invoice within your payment terms.
For example, if you have given seven (7) day terms, then that debt becomes a bad debt if it remains unpaid on day eight (8).
However, there are a number of steps that a business owner can take to reduce of minimise these bad business debts, increase cash flow, and increase profitability.
How can I Avoid Bad Business Debts?
Section 95A of the Corporations Act 2001 (Cth) defined insolvency. It says:
(1) A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable.
(2) A person who is not solvent is insolvent.
Lack of cash flow can mean that a company is insolvent and runs the risk of being wound up in insolvency.
We have devised a three (3) step process for managing bad debts in business.
These steps are:
- Client management;
- Credit management; and
- Debtor management.
Client management relates to the steps that a business can take prior to the client / customer being offered trade credit.
Credit management relates to the steps that a business can take setting up and managing the trade credit.
Debtor management relates to the steps that a business can take with delinquent or bad debts when the customer defaults.
Bad Business Debts – Client Management
There are a number of tips and things to consider during the client management stage.
These include:
- Choose your clients / customers carefully;
- Do a credit check and assess their creditworthiness;
- Reference checks before you offer credit to new customers;
- Investigate your customers on Google and social media;
- Check where and to whom the invoices are to be sent;
- Find out whether customers operate a payment run (monthly, 60 days, etc);
- Factor the potential for payment delays into your cash flow forecast;
- Investigate trade credit insurance options; and
- Advise your clients about scam emails
These will be explained in more detail below.
Choose your Clients / Customers Carefully
It is very important to choose your customers wisely.
One bad customer can create a huge amount of lost time and stress trying to recover the bad debt.
So much so that it is actually better for business if you do not have them as a customer.
If you take the time at the beginning to do some preliminary investigations, then it could save you a massive headache when experienced debtors inevitably default.
Do a Credit Check and Assess their Creditworthiness
One way to check on your client is to do a credit check.
A credit check can be done with one of the credit reporting agencies such as Equifax or Illion.
Get a credit check for the company and also the director of the company to see if they have any defaults or judgments on their credit record.
Also, to be extra-careful you could do an ASIC historical director search to see if the director of the current company was (or is) the director of another company in liquidation or with a bad credit score.
Reference Checks before you Offer Credit to New Customers
You should always obtain at least three (3) trade references for your customers – and actually call them and check up on them.
There is no point asking for references and then not calling them and asking them questions.
Ask the trade references if they are good payers, if they were ever late with payment, and if they would offer credit to them again in the future.
Investigate your Customers on Google and Social Media
Spend 5 or 10 minutes Googling the business / company / person and see what comes up. It is surprising what you will find.
A lot of people take to the Internet or social media when they have not been paid by a debtor, so if they are bad payers then there could be a wealth of information there.
A search of the ASIC Insolvency Notices website for any insolvency related events.
Also check the Courts website for any current or historical proceedings that may need to be addressed.
Once you have all of this information, you can make an informed choice about taking them on as a customer.
Check Where and to Whom the Invoices are to be Sent
One of the biggest excuses we hear is “we didn’t receive the invoice” which, after sending 9 times, becomes difficult to believe.
Get a number of different emails and people to send the invoice to. This can include the director, the accounts person, even the accountant.
If they default, then send it to reception too.
Find out Whether Customers Operate a Payment Run (monthly, 60 days, etc)
Ensure that you have familiarised yourself with the customers payment run. They could simply have 30 or 60 days as a matter of internal policy.
Government agencies do this and although they will usually pay, it is worth understanding what their payment run terms are.
For example, if its 60 days, then you might want to think if you can wear that on your books.
Talk to your accountant about this.
Factor the Potential for Payment Delays into your Cash Flow Forecast
While speaking with your accountant, it will be worth asking them about the potential for payment delays into your cash flow forecast.
A business owner must identify how much cash the business is going to get in from payments, interest, service fees, collection of bad debts, and other income, and when?
Identifying the risks early can inform you to be able to take measures if required.
Again, speak to your accountant about managing payment delays in your cash flow forecast.
Investigate Trade Credit Insurance Options
Another option to mitigate risk is the option for obtaining trade credit insurance.
Trade credit insurance insures a business against your customer failing to pay your invoices, covering every invoice with that particular customer for the term of coverage.
Again, you should seek professional advice in relation to if trade credit insurance is right for your business.
Advise your Clients about Scam Emails
There has been an increase in email scams in recent years.
These are sometimes called the business email compromise (“BEC”) scam, or the CEO scam.
Basically, a hacker hacks the business, sending fake emails to the customer stating that they have changed bank accounts and that invoices are to be paid into a new account. This being the account of the thief.
We are seeing this more and more in our debt recovery practice.
It is vitally important that you include in your terms and conditions that any changes to bank accounts must be confirmed in writing, or the customer is liable for the debts.
Moving Forward
If you feel comfortable with taking the new client and providing them with credit, then there are a number of things that you can do to manage the credit.
Bad Business Debts – Credit Management
There are a number of tips and things to consider during the credit management stage.
These include:
- Enter into a written credit application;
- Establish debt collection procedures;
- Set realistic credit limits with the debtor;
- Set your payment terms and penalties;
- State your terms and conditions clearly on business documentation;
- Invoice quickly and properly with sufficient detail;
- Get sent / delivered receipts or use XERO / MYOB;
- Give discounts or incentives for early payment;
- Stay in touch with the debtor;
- Approve additional credit extensions in advance;
- Strict processes for payment and follow up;
- Up to date systems and processes; and
- Money upfront / cod for bad payers.
These will be explained in more detail below.
Enter into a Written Credit Application
I cannot emphasise this enough. Enter into a written credit application with the best clauses to protect you should the debtor default.
As a minimum these clauses should include:
- Definition of default and breach;
- Security for the debt;
- Personal guarantees;
- Legal & debt collection costs upon default; and
- Default interest.
For more information of credit applications – Visit our credit contract page.
Establish Debt Collection Procedures
It is vital that you establish debt collection procedures and accounts receivables processes.
These processes in the credit application will help you if and when the customer defaults and does not pay their invoices.
Good debt collection processes established from the start of the relationship is vital if the relationship goes wrong.
Set Realistic Credit Limits with the Debtor
To reduce the risk of bad debts it is important that you set realistic credit limits.
Setting credit limits that work for both you and your customer is a great way to minimise the amount of outstanding debt owed to the business upon default.
Minimise your bad debts by setting realistic credit limits, enforcing that limit, and not providing further goods and/or services until that limit has been paid down.
Set your Payment Terms and Penalties
You can reduce bad business debts by setting your payment terms and enforcing them.
If the customer pays outside of these payment terms, then you should have strict penalties which should be applied upon default.
Setting these payment and penalty terms early and strictly enforcing them is key to reducing bad business debts.
State your Terms and Conditions Clearly on Business Documentation
It is important that you state your terms and conditions clearly on all business documents.
State the payment terms on each invoice, and on your statements to that company.
If you enforce your terms with your customer a number of times, then it will be less likely that the customer will default.
Invoice Quickly and Properly with Sufficient Detail
It is vital that you invoice quickly. Invoice on the same day if possible, or the next day at the latest.
If you have a busy business then it might be difficult to keep on top of sending invoices quickly, but you must implement a procedure so that this happens.
It is also important that you particularise the details on the invoice correctly. If the customer defaults, then you have ensured that there cannot be any confusion in relation to what the invoice was for.
This is especially important for issuing building and construction payment claims, or when issuing statutory demands.
Get Sent / Delivered Receipts or use XERO / MYOB
If you are sending the invoices by email, then it is important that you get a read receipt and a delivery receipt. These can be used as proof that the invoice was delivered and/or read by the customer.
A delivery receipt and a read receipt can be obtained in Outlook by doing the following:
- Step 1 – From the email you are sending the invoice – choose “options”
- Step 2 – Click inside the “request a delivery receipt” box with a tick
- Step 3 – Click inside the “request a read receipt” box with a tick.
Once this has been done, you will get a receipt to show that the email has been delivered.
However, the customer will have to send a read receipt, which they generally do not do.
Alternatively, if you send your invoices from inside MYOB or XERO, then it tracks if the invoice has been delivered, opened, etc.
Give Discounts or Incentives for Early Payment
You can also give discounts or other incentives to encourage early payment of invoices.
This can be a percentage discount off the total of the invoice, or incentivise the customer in another way, such as still receiving goods / services from the business.
A business can also provide disincentives for late payments to reduce bad debt such as penalty interest, or late fees.
Stay in Touch with the Debtor
Communication is the key to an effective bad debt reduction strategy.
Most people will not mind if a customer is a few days late with payment as long as it is communicated correctly.
Contact the customer the day before the default and speak to them about paying the debt. Can they pay? If not, why not? Have they already paid?
Having a good line of communication with your clients is a great way to keep on top of bad business debts.
Approve Additional Credit Extensions in Advance
Sometimes a customer will be nearing their credit limit and then seek to get more goods / services on credit.
It is important that a business has systems, checks, and balances in place to ensure that (a) the customer cannot go over their credit limit; and (b) any increases to the credit limit are approved by management, or not.
In our practice we have seen cases where these systems were not in place and the customer was allowed to run up considerable debts, unbeknown to anyone at the business.
Strict Processes for Payment and Follow Up
As part of the processes for managing credit with a customer, a business should ensure that strict processes for payment and follow up are implemented.
Perhaps a reminder set for 1 week before the due date; then 2 days before the due date; then the day before the due date.
Getting out in front of these bad debts will be the key to mitigating any bad business debts.
Up to Date Systems and Processes
It is also important that you keep up to date systems and processes. If you have identified a gap in a process, then change it.
Keep an ‘accounts receivable manual’ for example, and keep changing, updating, and evolving these processes to make them tighter and tighter.
Also, consider utilising technology to better reduce of minimise bad business debts. There are a number of different accounts receivables software on the market, and this could be a great investment for your business to minimise exposure to bad payers.
Money Upfront / COD for Bad Payers
If you think that a customer will likely be a bad payer, then you can simply ask for payment upfront or cash on delivery (“COD”) to start, before offering credit.
Alternatively, a business could structure a 50% upfront and 50% credit to begin with.
A business should not be afraid to offer an introductory period to a new credit customer, or an introductory 7-day payment terms, for example. Let the customer prove themselves first.
However, although you can take every precaution to mitigate the risk of incurring bad business debts, it is still possible that you have a debtor who does not pay their invoices.
In that case, you will need to have some debtor management options.
Bad Business Debts – Debtor Management
There are a number of tips and things to consider during the debtor management stage.
These include:
- Chase payment immediately a debt is overdue;
- Follow your debt collection procedures;
- Offer the debtor a cash discount for immediate payment;
- Resolve any debt disputes quickly;
- Reconsider the business terms with regular late payers; and
- Use debt collection lawyers.
These will be explained in more detail below.
Chase Payment Immediately when a Debt is Overdue
Notwithstanding all the attempts a business has made to stop the late payment, if a payment is late it is important that a business chases payment immediately when a debt is overdue.
The very next day after the due date for payment, the business should send a friendly overdue payment letter, followed by increasingly more demanding letters as time goes on.
If a business can quickly jump on bad debts, and keeps seeking to recover overdue payments, then this will likely encourage the debtor to pay.
Follow your Debt Collection Procedures
A business should follow its debt collection procedures.
If the credit contract has a charging clause, then lodge a caveat. If the credit contract has a PPSA clause, then seek to recover the collateral.
Send a letter of demand to the customer and any of the personal guarantors.
By starting with the debt recovery process and procedure, it may encourage the debtor to pay rather than risk losing person assets or having to pay legal costs for legal action.
Offer the Debtor a Cash Discount for Immediate Payment
Another thing to consider is compromising the debt and accepting a discount for immediate payment of an overdue debt.
If you are forced to commence legal action to recover this debt, then you will always lose money in legal costs. Even if you obtain an indemnity costs order, it will still not compensate a business 100%.
With this in mind, a business should consider offering a discount for immediate payment. This will increase cash flow and save on legal costs.
Resolve any Debt Disputes Quickly
Sometimes a debtor will not pay because they dispute the goods / services. This may be that the goods were not merchantable quality, or the services were not provided correctly.
As above, we always advise clients to try to resolve these debt disputes quickly, because the longer a dispute drags on, the more money you will spend on legal costs and the chances of resolving the dispute become less and less likely.
We would always recommend that you engage a lawyer to negotiate a settlement to a debt dispute.
Reconsider the Business Terms with Regular Late Payers
If a customer continually pays late, then you should ensure that the credit application is able to be changed by the business.
A business can reconsider the business terms with regular late payers to ensure that the business is fully protected against bad business debts from this customer.
If the customer wants to continue with the commercial relationship, then they will enter into a new credit contract.
Use Debt Collection Lawyers
We would always recommend that a business engage debt recovery lawyers to resolve the debt dispute.
Contact us for advice and assistance in relation to reducing and minimising exposure to bad business debts.
WE CAN DRAFT OR AMEND NEW CREDIT APPLICATIONS
CONTACT US TODAY & SPEAK TO A LAWYER
OR CALL: 1300 545 133 FOR A FREE PHONE CONSULTATION
