How to Avoid Bad Debt in Business
Incurring multiple bad debts can cause serious cash flow problems. Don’t let this happen to your business. Maintain a strong bottom line by learning how to avoid bad debt in business.
What is bad debt and why you should avoid it?
Bad debt is a receivable that you cannot collect because your customers show no intention, or are incapable, of paying the monetary amount they owed to your business. It happens when customers buy a product on credit rather than paying up-front. If they fail to pay for their dues, your business may lose that amount. Instead of earning from sales made through credit, it turns into an expense.
Neglecting a bad debt can wreak havoc on your cash flow. Not only does it reduce the capital for your daily operations but it also prevents your business from growing. If the total amount of bad debts piles up, you may even run the risk of bankruptcy.
While it’s true that you can’t totally avoid bad debts, you can still have them under control. Before you extend another credit, learn the policies and procedures you can implement to prevent bad debts.
How to avoid bad debts in business?
Protect your business from incurring bad debts by executing efficient rules around credit management. Here are some best practices you can follow:
Filter your customers
Not all customers are good for your business. If your goal is to build strong and lasting relationships with your customers, you should make an extra effort to choose who you’ll want to work with.
To determine if it’s safe to qualify a customer for a credit plan, consider these steps:
- Create a profile of customers you want to target.
- Assess the creditworthiness of a customer by checking their credit score.
- Ask interested customers to fill out a credit application form.
Require up-front payments
Requiring customers to pay in cash lowers your risk of incurring bad debts. Its downside, though, is it may drive away a good customer who prefers to shop using credit cards.
Set reasonable credit limits
Set reasonable credit limits for new customers according to their creditworthiness. It’s important to play safely at first until you can affirm their reliability. Once they give you the guarantee of being good-paying customers, you can start increasing their limits.
Provide clear payment terms and penalties
Clearly state in your terms of trade agreement the conditions and penalties for late payments. Make sure your customers understand what it means to prevent any miscommunications. Let them know of the penalties they may get due to late payment. Most importantly, ensure that they agree with your terms through a signed document or a confirmation on your website.
Improve your accounting
Staying on top of your finances lets you determine customers who are paying on time from those who are falling behind. Hiring an accountant helps you organize and improve your accounting processes. With extensive knowledge about how business accounts work, an accountant can provide you with insightful reports on your current financial standing and effective strategies to improve it.
Implement strict collection procedures
Let your customers know how serious you are when it comes to collection. This way, they will prioritize you over other creditors. Some of the activities you can do to ensure you’re in front of your customers’ minds are:
- Sending them follow-ups before, during, and after their payment schedules through appropriate channels.
- Sending accurate invoices as soon as possible.
- Put transactions on-hold. Stop supplying to customers who haven’t paid their dues yet or have exceeded their credit limit.
- Offer incentives to outstanding payers to encourage them to pay on time. It can be a small discount or cashback.
Use cloud-based software for debt collection
Track delinquent accounts faster and more accurately with the use of cloud-based software. It can help you automate most of your debt collection processes, allowing you to save time and effort in bad debt recovery.
Recovering bad debts takes a lot of effort. Before you reach the point of chasing after non-paying customers, it is better to prevent it by developing tight credit policies and procedures.