How to Avoid Bad Debts and Insolvency by Managing Customer Risks

How to Avoid Bad Debts and Insolvency by Managing Customer Risks
  • It’s risky to depend most of your revenue from one customer source.
  • Do a background credit check, create clear business terms or reconsider when necessary.
  • Sync payment systems with your customer and check payment contacts are up to date.

 

Tighter lending regulations, technological disruption and changing consumer habits are creating a challenging landscape for small-to-medium enterprises (SMEs). Not only do you have to be at the top of your game, but also that of your vendors and customers. After all, what would happen if your main customer were to go ‘belly up’?

As an insolvency specialist with over 20 years’ experience working with SMEs, I’ve seen the devastating effects late or non-payment of debts can have on a business. It can cause serious cashflow problems, harm staff morale, jeopardise supply and demand for other customers, financial investment losses and, in extreme cases, end in insolvency.

While these aren’t new challenges for startups and SMEs, the current financial landscape and shaky economy is making it even harder for customers to pay their bills on time. My insolvency colleagues and I continue to hear from businesses of all sizes that are owed money, which commonly results in costly litigations.  

Just recently, one small business working under a contractual relationship had a payment withheld. The snowball effect meant that the business couldn’t meet employee costs and was unable to continue.  While it was not the only reason for their demise, the cashflow impact of non-payment can be catastrophic.

Chasing debts, as you most likely know, can be an awful experience – not to mention a time and money-waster. And the arduous process of contacting individuals and companies means that you are not doing what you should be doing to run and grow the business.

Therefore, it makes sense to protect yourself – and seek advice early.  It is essential for SMEs to know that credit, whether you are seeking it or providing it, is not a right but a privilege.  Your financiers and suppliers expect you to meet a certain criterion before they lend to you, so why would you not hold your customers to an equally high standard?

Mitigating the risk of defaults

Insolvency specialists aren’t the only ones seeing red financial flags, says Small Business Association of Australia founder and CEO Anne Nalder.

“If an SME relies on more than 80% of payments from one source, that is a recipe for disaster because if that customer doesn’t or is unable to pay you, most businesses can’t recoup that type of loss,” she says. “There is no such thing as risk-free – even if all the checks and balances have been made, as a business could close its doors the following day.”

While customers are valuable assets regardless of what sector a small business operates in, Anne says they can also be considered liabilities. “That is why owners must ensure that they take the appropriate measures to understand, manage them and mitigate the risk of a client default,” she explains.

Key tips for managing your debtors or buyers:

  • Check the ABN on the purchase order, service agreement or contract.
  • Always ask for a credit application to be completed using the buyer’s ABN.
  • Conduct an appropriate credit search on the ABN (not the trading names)
  • If necessary, conduct a business name search.
  • Monitor payment behaviour and take action if necessary.

“These measures create a safety net in case the small business owner has been given incorrect information, such as finding out that no such business – or ABN – exists,” says Nalder. 

Vendors or customers who consistently pay late can cause startups and SMEs considerable financial distress. But what constitutes a late payment? How long is too long?

“Many businesses pay either fortnightly or monthly, but it is known that large corporations pay as late as 120 days, which is unacceptable,” she explains. “This drains the cashflow of a small business.

“The difficulty is what to do, as a small business may rely upon that business for its day-to-day operations. If the small business can wear the lateness of the payments and the late payer is considered a good client, I would stay with the arrangement.

I’d also recommend contacting the owner of the business, or the accounts department it’s a corporation, to find out why payment is consistently late. Sometimes it can be the fault of the small business owner with incorrect or incomplete tax invoice details which creates the delays.” 

Safeguarding against bad debtors is as much about minimising short-term risk as it is protecting a business’s future growth and profitability.

“A small business needs to run a lean operation by having low debt, ensuring that transactions such as leases and other legal requirements are reviewed by a lawyer prior to signing, and if entering into a partnership with a person or persons, ensuring a legal agreement is prepared,” Nalder says.

6 financial tips for SMEs

While every business is different, there are a few processes that you can put in place to help reduce and better manage late or non-payment of debts.

1. Background credit check

Ask new customers to provide trade references or invest in an online credit check. Consider setting a lower credit limit for new customers until you are confident that they can pay you on time.  Sales are not profit until the money lands in your account.  Always approach any business relationship with a level of scepticism to ensure that your systems protect you from the emotional impulse generated by the “sale”.

2. Terms of trade

Make your terms and conditions clear from the onset. Send a copy with your goods and invoices and make them prominent on your sales collateral and website for people to refer.  Good terms of trade set a standard for the business relationship. 

Be fair, honest and upfront from the outset, educating your customers on how you expect them to trade with you.  Good terms of trade assist with any tough conversations that may need to occur in the future.

3. Ensure contacts are up to date

It might sound simple, but invoices are often sent to the wrong person or department.  Back office admin is as important as your product or service.  A job is not complete until you have been paid, so do not ignore the most important part of that process.

4. Find out your customer’s payment system

Consider adjusting your schedule to fit in with theirs.  Make it easy for your customers to pay you.  If you understand the requirements of your customer’s internal systems, then work with their team, and you will likely reduce late or non-payment.

5. Reconsider the business terms

With customers that regularly pay late, don’t be afraid to increase the prices you charge them or cancel their credit facility.  Be prepared to have the tough conversation, remembering that your relationship is symbiotic.  Your customers need the product or service you offer.  You know the value of that, and you must ensure that you follow through to that value.

6. Seek help

if your attempts to recover the debt are unsuccessful, a letter from an advisor may be enough to prompt payment without any further action.  Good behaviours are cultivated; do not be scared to be stern if required.

Finally, when considering allowing your customers to have trade credit you must always ask yourself: “What happens if they don’t pay?”. One useful mitigator is insuring against bad debts to protect yourself. Trade credit insurance is a positive step as the approval process requires attention to the insured’s credit risk assessment protocols.  If the insurer will not accept the risk of the debtor, then surely you must ask yourself why.

It’s important for you to remain accountable for all aspects of your cashflow management, especially as many of the difficulties you may face are due to external factors. It is easy to never lose a dollar - just don’t risk a dollar. 

But in the world of entrepreneurialism, risk is a constant factor.  The question is really, do you understand that risk and are you mitigating it? I would encourage all business owners to discuss their specific circumstances with their advisors constantly, to ensure that they have all the information necessary to mitigate their risks.


Andrew Spring

Partner at

Andrew Spring has more than 17 years’ experience in corporate recovery and insolvency, gained through work in the UK, Europe and Australia. He has a wealth of experience in all facets of domestic and international business restructuring and insolvency. His specialist skills include independent business reviews, reconstruction and turnaround consulting, business sales and asset divestment, profitability reviews, cross-border insolvency, and all forms of corporate insolvency appointments.

Jirsch Sutherland

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