Operating a business can be rewarding and profitable, although with great responsibility comes great risk that must be meticulously measured. The financial health of a business is shaped by countless mitigating factors, some of which can be controlled, such as cash flow and company debts, and some that can’t be controlled, such as economic conditions and consumer appetite.
A common thorn for businesses is bad debt, as although the threat appears unmenacing on the surface, it has the potential to overturn a business. Jon Munnery of UK Liquidators, a business debt help expert, dives into the topic of bad debts, what they are, and why businesses must seek protection against them.
What is bad debt?
A bad debt is money owed to a business that is unlikely to be paid and, therefore, written off. A debt may be deemed bad if it is deemed uncollectible, which can be for many reasons, such as the debtor having a poor credit history, falling into financial difficulty, becoming insolvent, or being fraudulent.
If you extend credit to a customer, you must always expect to accumulate bad debt, although there are ways to minimise the risk, such as tightening up due diligence checks and establishing tighter payment terms.
Why are bad debts written off?
Bad debts are written off as they are unlikely to be paid; therefore, if included in reports, the financial position of the business will appear more favourable than it realistically is. To generate accurate cash forecasts and understand the true health rating of the business, bad debts should be removed.
Bad debts are part and parcel of operating a business and extending credit to customers, as although basic due diligence may be carried out, it’s not to say that all customers will act responsibly with their money. There are ways to recover bad debt, although the key is speed and strategy.
Can bad debts be recovered?
Bad debts can be recovered with the right support on hand, but to do this, you must be able to get to the root of credit control issues early. Whether it’s a single invoice or a string of multiple invoices, debt recovery efforts must be maximised to sustain company cash flow. You can adopt an in-house debt collection strategy or appoint debt recovery experts if the problem runs deeper.
Here are some ways bad debts can be avoided and recovered:
- Credit control: Streamlining the way your business is geared to send invoices, chase payments, store data, handle disputes, and take further action when payments are late or overdue. A controlled approach can help protect company cash flow and reduce exposure to bad debt.
- Invoice recovery: Targeting overdue invoices and requesting payment by asking the right questions or calling in specialists can be less stressful than seeking legal action as the first resort. This can be particularly useful if your business depends on a single client or a select few.
- Due diligence: This stage is made up of a series of background checks that are performed when a customer applies for credit to investigate their relationship with money. Each customer must be screened for any red flags and assessed for credit risk.
What action can be taken against bad debts?
If there’s no sight of payment after sending payment reminders and demands, you may seek legal action to recover the debt. This may take the form of a solicitor’s letter to the debtor, which touches upon interest and a late payment charge. A county court judgement is the next step up, which gives the debtor 14 days to pay up or otherwise risk a statutory demand. A statutory demand is legally binding and formally demands payment to be made within a set timeframe.
As a final resort, you may issue a winding up petition if the debt owed is £750 or more. If a winding up petition is successful, a winding up order will be issued by the court, which will result in the closure of the company.
Bad debts must be taken seriously, as if your business depends on cash to pay essential bills and staff wages, you run the risk of becoming insolvent once debts become uncollectible. Professional support from an insolvency practitioner or debt recovery specialist can provide a lifeline to your business if you act early.