How to Prevent Bad Debt in Business
Bad debt is one of the many factors of running a business. While many companies provide payment terms, those who don’t get paid the money they are owed will have a reduced cash flow, leading to business failure. This article will expound on what makes bad debt and how you can avoid it.
What Is Bad Debt?
Bad debt is a term used to describe any situation when money owed isn’t paid. Once a business provides invoice payment terms, or credit sales, customers are given a specific period to pay. However, if the amount owed isn’t paid with the business failing to recover the money, it becomes bad debt.
How to Avoid Bad Debts
Every small business deserves to get paid for the products it offers. However, that does not always happen. Still, there are ways you can reduce commercial bad debts in your business.
To start with, you need to have crystal clear credit policies and procedures to implement and follow. Have each customer fill up a credit application, then sign it, then check credit references and credit history to ensure that your customer (another business) has paid its debts in its past transactions with other companies.
If you’re unsure about your customer’s ability to pay invoices, then you can begin with a credit limit. You can slowly increase this amount once they’ve proven to stick with a scheduled payment on record. In addition, if a debtor has outstanding overdue invoices, you can prevent them from creating more credit purchases until the existing ones have been paid. Outline these procedures in your credit policies.
Once an invoice has been issued, you must follow up when it’s not paid by the due date. That is because the longer an account has been overdue, the more likely it is that it will become a bad debt. The written policies should specify that you will take necessary steps, such as calling and emailing about overdue payments.
How to Recover Bad Debt
If you have overdue debts despite making phone calls and sending emails, it’s time to let professionals handle the matter. Have a debt collection agency collect your money instead. Debt collectors specialise in tactics that will help you recover bad debts, including taking legal actions against the debtor as a last resort.
While hiring a debt collector to handle the matter for you, it can also come at a price. Agencies charge a commission depending on the amount of the debt recovered. Usually, it ranges from 5 per cent to 30 per cent of the invoice amount, with commissions higher for lower invoices and vice versa. That means you might end up paying the debt collection agency 30 per cent of a $1,000 invoice and 5 per cent for a $25,000 invoice.
If your business is selling products or services to other companies, you’ll probably experience late payments that turn into bad debts. And even if you are effective at avoiding it, it’s still highly likely that you’ll have late-paying customers that can negatively affect your cash flow. Moreover, chasing overdue invoices can be stressful, so sometimes, it’s best to let debt collectors handle the matter.
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