How to avoid bad debts

Paying your bills and issuing invoices on time are a big part of good cash flow management. If you miss a payment or fail to chase up a customer, you could rack up a debt collection that may place your business in the red.

Most businesses focus all their time and energy on pursuing customers that have late payments but may not realise that they themselves are not sending out a payment invoice on time or paying their own bills.

This will not only affect your business credit rating but may also damage the relationship with your supplier or landlord. These three tips will help you lower your chances of accumulating a bad debt.

Lower your risk

One of the biggest mistakes small businesses make is failing to collect outstanding accounts during periods of high cash flow. Instead, firms tend collect overdue payments when they are experiencing financial distress and need the cash urgently to either pay their own bills or cover day-to-day expenses.

This can be extremely damaging to a firm's cash flow cycle, as seen in Dun & Bradstreet's recent Trade Payments Analysis for the June quarter. Australian businesses took an average of 53 days to pay their bills, significantly longer than the standard 30-day period to pay company accounts.

The analysis also revealed that businesses with one to five employees had the worst deterioration, with average payment terms increasing by two days in the past 12 months. These figures reflect the lack of urgency SMEs have when following up overdue accounts.

This can be avoided by ensuring that you are paid before taking on new orders, and by sending out invoices to customers on time or as soon as the project is completed. Keep comprehensive records of each customer's debt and make sure to follow up any late payments with a phone call, letter or email.

Conduct credit checks

Another way you can avoid bad debts is by conducting credit checks on new or potential customers and suppliers to get a better sense of their payment habits. More often than not, there is a strong correlation between late payments and customers with poor credit profiles.

You can run a credit check on your customers, businesses and even potential employees to see a range of information such as bankruptcy, judgement data, defaults, past credit enquiries and directorship data.

D&B's credit reporting website  can also provide you with a more complete picture of a business's financial stability, payment patterns and overall risk profile. This will help you make an informed decision on whether to enter business dealings with that person or entity.

It is also a good idea to keep track of your business's credit history- or, if you're a sole trader, your personal credit history- to ensure that the information in the report is accurate and to see how your credit history is portrayed to credit providers.

Have attractive payment terms

An incentive to paying early can be as simple as structuring your payment terms in an attractive and stress-free way. For instance, you could offer a small discount to the customers who pay early or on time. Alternatively, you could provide disincentives to paying late such as charging interest on outstanding accounts.

According to National Australia Bank's small business guide, you should stand firm and not allow the discount if the payment is late, "even if it's only a day late". You can vary this for good or long-standing customers but you should "make it clear that you're breaking the rules this one time because you value the business relationship".

Ensure that your customers sign a declaration indicating their acceptance of your terms and conditions so that you can enforce them when necessary.

By lowering the risk of late payments and making sure your payment terms are clear, your business will be able to strike a healthy balance between accounts receivables and accounts payables.

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