How to deal with bad debt for every business owner
Debt is a fact of business life. At all times you are going to have clients or customers owing you money, or a bank holding funds in escrow, or even services rendered under dispute. A business owner’s dream of having unhindered cash-flow and being bad debt-free is unrealistic; rather, business owners should strive to manage bad debt and learn how to control it as much as possible. This article explores ways of dealing with bad debt, and how to get paid before it’s too late.
What is bad debt?
There are two types of debts. Good debt is the type that is backed by assets. An example may be a business awaiting payment due to a construction project finishing or government contract to be paid. The law guarantees these payments, and you only need to wait for the necessary paperwork to be cleared in order to be paid. In these scenarios, you need to manage expectations and time (see tip three if you are waiting for a prolonged period of time).
Bad debt is when a firm cannot pay, and it is not clear when they will have either the time or the resources to do so.
Now that we understand the difference between good debt and bad debt, we can discuss the best practices to manage the dark side of debt.
1. Categorising debt
One of the most painful experiences for a business owner is going through their unpaid invoices and understanding the depth of the bad debt. Like an iceberg, only looking at the financials above the water will paint an inaccurate picture of your accounts. You need to see the good and the bad to get a good idea of your financial position.
The best way to do this is to start by asking questions. Put each debt into a list with the following rows:
First, understand who owes you debt:
● Who owes the debt?
● Are they still in business, solvent and trading?
● Are there any legal issues facing the firm at the time?
● Are they awaiting a big payment themselves?
● Are they a corporation or a sole trader?
● How long have you been working with them?
● Do you have a personal relationship with them?
● Are there others on the market who can replace them?
Second, the debt owed:
● How much is the debt?
● When was it due?
● How much time has passed?
● Why was the debt not paid? Is there a dispute? Does the client need the job finished to deliver to its clients?
● Does the client have a history of unpaid/late payments?
Once you have understood this for each debt, you can now categorise them in terms of priority and take action.
2. Take action on unpaid debts
For those debts that are the biggest, owed the longest, by solvent firms that you don’t personally know (and haven’t worked with long) can be the focus for your first move.
The above might seem like self-evident advice, but the truth is that sometimes the most apparent action is the most painful to do. It is time to rip off that band-aid and take the uncomfortable action to earn your well-deserved funds.
We have a practical guide that shows you the pathway to recover the debt owed to you.
The core message here is to take action as soon as possible. Now that you understand the magnitude of debts, you need to hunt it down as quickly as possible.
Following this point, make it easy for your clients to pay you. Speak to them and understand the cause of their debts, and see if you can negotiate a payment plan to resume cash flow in the following weeks. The number one cause of business failures is cash flow, and you don’t want to join those statistics.
3. Reduce financial liabilities
While you are recovering the bad debt owed to you, it’s best to examine your own business and reduce any financial liabilities that might put you in a risky position. Don’t let the financial mistakes of others affect your business.
Have a look at your current outgoings and decide what is essential and what is a ‘nice-to-have’. If you are facing the prospect of your firm operating without significant cashflow until that debt is paid, it might be practical to have a worst-case scenario action plan in place. What can you cut that does not directly lead to additional sales or income?
Additionally, reducing liabilities doesn’t have to be black and white. Talk to those that you regularly pay outgoings (such as office space landlords, or software providers, etc.) to see if you can negotiate a reduced rate or pause in payments for a time. They are human, and if you reach out before you are unable to pay them, they will greatly appreciate it.
As a last case scenario, as we have seen with the COVID-19 crisis that hit our country in early 2020, ask your employees to take paid leave or a break from working. Wages are one of the highest costs of business, and it might be practical to see how you can reduce that expenditure.
4. Prevent it from happening again
There is something to be said about hindsight, and no lesson will be bigger than surviving this one for your business. Make sure that any new invoices that are going to be issued do not leave much room for interpretation and that they protect you for bad debts. Go over your payment terms, contracts and deadlines to ensure that it is more beneficial for your current situation.
We have a great article on how to set up your contracts to ward off the worst of bad debt (and get paid sooner). Check it out here.
Don’t let bad debts control your business! At Professional Recovery Services we understand the difficulties of doing business and how bad debt can have a negative impact on your operation. If you need assistance in recovering monies owed to your business, contact us today to discover how we can help.