How to avoid a bad debt

Return to menu

	Introduction			It is a sad fact of business life that no matter how careful you are over credit control, one day a customer owing you money will go bust. The following suggestions will hopefully help you avoid debts you will never collect. The amount of effort you put into researching the creditworthiness of your new customer will of course be tempered by the costs involved. If you make low-value, high volume sales to many different customers, then the odd bad debt is not going to warrant detailed credit checking on every client. This will not be the case if you make high-value sales to a small customer base. Credit checks on all new customers would almost certainly be a justifiable expense. You may also decide to regularly review your customers' credit ratings. A client's financial position can change very quickly and knowing about a sudden adverse change in their circumstances may just save you from continuing to trade with them on the same terms and suffering an otherwise unnecessary bad debt. It is also worth remembering that giving credit to a customer is a privilege, not a right. We work on the basis that you haven't made a sale until we have been paid. We might find the odd customer takes their business elsewhere because we won't extend credit terms, but we prefer that to bad debt.
	Steps you should take for all customers			Make sure your customers are clearly informed of your terms and conditions of trading. There is much to commend printing your full terms on every sales invoice. It is wise to ask a solicitor to check over the terms to ensure the are legally enforceable. If you supply tangible goods, then make sure your trading terms clearly state that "the goods remain your property until settlement is received in full". This is sometimes referred to as the Romalpa clause. Provided your goods can be separately and clearly identified there is a chance that by retaining title until they are paid for, you will be able to recover them from a customer in default. Even if they enter into some insolvency arrangement. Never assume that just because a customer paid their bill promptly last time, they will do so again next time. If you have good reason to doubt their creditworthiness, ask for payment-on-delivery. You can now purchase some very easy to use accounting software, with price tags below £100. Even if you use such software just to maintain a sales ledger, you will benefit from the instant management reporting and credit control functions they offer. To be able to print off an aged debtors report, or determine the average number of days each of your customers take to pay their invoices, can help you spot the late payers. A few early calls to chase outstanding debt, can stop a minor problem becoming a major one. Consider sending monthly statements to your larger clients. Statements are a very effective credit control tool that encourage prompt payment. Prompt payment discount schemes can work for some. They can be tiresome to administer, and the late payers often take the discount even though they have not paid on time. New customers Always take up trade references with new customers. One of the reasons why a customer may swap suppliers, is that they have exhausted their credit with the previous one. Carry our a company search. Take a close look at their most recent financial statements, particularly at the ratio of their current assets (bank and trade debtors, but exclude stock) to their current creditors (trade, bank and tax creditors). A healthy business should have a ratio in excess of 2. Less than 2 indicates they may already be experiencing cash flow problems that may affect your ability to collect prompt payment. Less than one is a clear indication the business is not able to pay its way. For all practical purposes it is probably already insolvent. Use a credit-checking agency to provide a credit rating for your larger clients. The cost of a credit check is comparatively low, particularly if you source a reputable agency over the Internet. If the business has any recorded County Court Judgments (CCJ's) against it, then you should be on guard. A history of previous insolvency should also make you think twice. Existing customers If an existing customer doesn't pay on time, then stop their account. Only reopen it when they have paid off their debt in full. Be wise to the customer offering to pay off just the older debts. To see them pay off £1,000 of an overdue £3,000 debt, and then allow them to place a new order immediately for £2,000 defeats the purpose of credit control altogether. Devise a system whereby late payers can be identified, and promptly investigated to see why payment has not been forthcoming. It may be that the customer is simply withholding payment to get your attention. Rectify their grievance, and remove the obstacles to receiving your money. Regularly review your sales ledger, and look for potential bad debt. A poor payment history, and increasing debt are clear signs of a customer under financial stress. Stop the rot at an early stage and minimise the damage. Look out for the frequent tricks of the unscrupulous trader with cash flow problems. Withholding payments of large sums for minor complaints is one method. Always paying small amounts that can never be reconciled to individual invoices is another. Whilst you are trying to sort out the confusion they have created, it is too easy to miss the fact that the overall debt is growing each month.
	Last resort			If a customer assures you "the cheque is in the post" and it doesn't arrive, consider collecting it in person next time. It is harder to fob you off with an empty promise, if you are are standing before them. Only send a pending legal action letter if you intend to carry out your threat. A letter from your solicitor will carry more weight, and you can always add their costs to the amount demanded. If your claim is good, and you are confident of winning judgment, then don't hesitate to go to law to recover your debt. A county court summons arriving on your customer's door step usually produces a quick settlement, provided they are solvent. A small claims track summons is ever so easy to put into motion. Consider using a reputable debt collection agency, but exhaust every avenue yourself first. Such agencies usually succeed only because their letters of pending legal action sound a lot more convincing than your own.