What Are Bad Debts And How Can You Avoid Them?June 11, 2022
There’s no other way to put it. Bad debts are bad news.
As a team of experienced insolvency practitioners, Chartered Accountants, and business owners, we are well versed in what bad debts are and how can you avoid them.
Not all bad debts are made equal, but significant bad debts can be enough to put a company out of business.
All business owners should have an understanding of bad debts and how best to avoid them in order to protect the financial health of their company.
What are bad debts?
A business incurs a bad debt when a customer hasn’t paid for goods or services provided and all avenues for debt collection have been tried.
The business is forced to accept that the sum will never be reclaimed and therefore needs to be written off.
Note: it is possible that a bad debt may be paid off at a later date and company accounts would be updated to reflect this.
However, should appropriate efforts have already been made to collect the debt but to no avail, for the sake of accurate accounting the write-off must be recorded in a timely fashion.
The consequences of bad debts
Bad debts can have wide-ranging negative consequences for a business.
Of course, if company income is impacted, the day-to-day running of the organisation is likely to become more challenging.
For example, buying stock or hiring new staff may have to be limited, and plans for growth put on hold.
Equally concerning is the circumstance where a business struggles to pay its own debts if invoices go unpaid - beginning a vicious cycle of debt.
Indeed, if the bad debts are large enough and a company is forced to write off significant sums, there may be a risk of business insolvency and a need to engage professional support to examine company debt solutions.
On a more general level, a high number of bad debts reflects badly on the management of a business.
It strikes staff and customers as disorganised and that financial prudence and management are lacking in the company.
Bad debt provision: How to avoid bad debts
It is important to have provisions for bad debts in place, and without a doubt, it is better to operate in a manner that avoids bad debts being incurred (so far as possible) rather than attempting to deal with them retrospectively.
While you might not be able to predict whether a client is going to run into the sort of financial trouble resulting in invoices going unpaid, it is advised to carry out some due diligence.
Take a look at their accounts at Companies House to ensure they’re solvent. And if you aren’t 100% confident in their ability to pay, consider setting a credit limit on their account to ensure bad debts don’t accrue too dramatically.
Make sure payment terms are agreed ahead of starting any work. Indeed, you may wish to ask clients to make a part of full payment up front.
This not only shows your client’s commitment to your service, but it avoids any issues with late payments afterwards.
Clarity around payment terms is vital.
Be sure to give client’s the opportunity to ask any questions before having them sign the contract so there aren’t misunderstandings down the line.
Make it easy for clients to pay their invoices.
This is simple enough, but we see some organisations even failing to put their bank details on an invoice - assuming clients already have these to hand.
Simple payment methods can also help.
Options like PayPal or Stripe, or a Direct Debit collection service such as GoCardless can really add efficiency to the process - making it less likely for payment to be delayed.
On completing a project, be sure to invoice in a prompt fashion and ideally synchronise sending during the client’s payment run.
And if it goes unpaid? Chase, chase, and chase again.
This is well within your rights as per the payment terms of the contract and can be the difference between accruing a bad debt or not.
Finally, avoid, where possible, working with just one large client.
In certain sectors, this isn’t an uncommon practice, but it places a business at risk should the client run into financial problems and bad debts start being accrued.
What are bad debts and how can you avoid them?
Whatever provisions a business takes, there will always be some risk of bad debts occurring.
And, given the current market instability and supply-chain pressures, it is prescient to be aware of this.
In spite of the arguably heightened risk at this time of companies struggling to pay their invoices, there are actions to take to limit the likelihood (and size) or bad debts.
If your company is struggling to pay its debts, or if the accrual of bad debts is threatening the business.
It is worth speaking to an insolvency professional in order to assess the potential options available to help manage the issue and keep the business on track.
For further information, don’t hesitate to get in touch with our friendly and professional team.