Even if you are efficient in avoiding common bad debts using an effective credit management and policies, you still need to anticipate them. You can always have bad debts rising from time to time. If a counterparty fails to pay in time regardless of their circumstance, you could cause serious cash flow and implications for the business. Coping with bad debts requires closely following the business process with an effective strategy.
One of the main solutions for reducing bad debts and the effects that come with them, is to monitor your suppliers. There is always a risk of giving away gifts and never receiving full payment for them.
What Causes Bad Debts?
Bad Debts are eminent in any business and arise from a range of reasons. They are always associated with crises in cash flow for businesses that introduce credit opportunities in recession periods. It may not be possible to acquire enough information about counterparties to foretell whether they will honor their end of the bargain. Although this is the most effective way to avoid bad debts, it is not practically possible.
Modelling an Effective Strategy to deal with Future Credit problems
Tight credit control will help you stay away from the risk of bad debts. This is in fact, your first line of defense when it comes efforts for maintaining the financial health of your business. To ensure effective management of your credit, you need to first formulate a new terms of trade agreeable by the accountant and approved by your lawyer. Show it to the customers and let them sign the terms soberly before extending credit terms to them. This formal agreement will improve the seriousness of the interaction, as more customers will be reminded of the consequences of debt failure.
Avoid Bad Debts
Avoiding bad debts is the desire of every business. Company credit ratings provide a good alternative measure of counterparty risk. However, most companies still maintain sales teams to provide the initial indications for counterparties with cash flow difficulties. Relying on sales teams is dangerous and poses more trouble for the business. Firstly, sales personnel focus on meeting targets. Unless their role includes collecting the cash, the interests of the sales department will not reflect the interests of the company. It remains as information they are accessible to easily because they have the memory. The bigger problem is that there will be a delay before they report this problem. This delay can jeopardize the efforts to recover the debt successfully. In case the problem affects a major customer, the financial stability of the supplier is in jeopardy.
Focusing on supplier information is therefore, key. Every business issuing out goods on credit should devise a mechanism to track supplier performance to grasp any changes in the routine payments. Most of the successful companies have updated information on their suppliers to help them stay ahead of the bad debts.
Minimizing the Impact of Bad Debts
The first step to adequately manage bad debts is to accept the fact that they are inevitable. Recognizing that some debts will never be paid calls for preparation to deal with the impact. This means devising a method of reducing the impact if or when it occurs. Since the consequences of bad debts extend beyond the company issuing the debts, it is vital to spread the cost. Bad debts are beyond the control of the company issuing the loan and finding some bit of control is important
Measures to reduce the chances of dealing with defaulting counterparties is one major step to this strategy. The key to reducing exposure is credit management. You may never be able to completely stay away from bad debts and the earlier you recognize this the better for you. This will help you prepare adequately for the upcoming problem.
Reduce Credit Terms If You Detect Credit Risk Early
You should also be thorough with checks and follow up of the customers before granting items on credit. To do this, you must complete a credit assessment and reference checks. Avoid offers that are unreasonable in the market. They may help you beat the competition but put you at risk of losing the sales. You should therefore, focus on fair credit limits that are acceptable and reasonable. Arm your staff with the necessary knowledge about the credit terms so they can explain it explicitly to the customers. Include extra terms such as conditions for exceeding an agreed limit. Let the customers understand the terms properly to avoid misunderstandings that may emerge in future. These credit extensions should be done in advanced and on good faith after commitment to pay the installments.
Purchasing credit insurance policies will help you reduce the risk of bad debts too. This technique works by sowing the likelihood the insured making a claim against the policy. Credit insurance policies may not be economic in case you have made the effective credit management policies already. These policies have limitations too. For example, it is not possible to buy policies against the chance of bad debts exceeding a certain level. Identification and valuing risk with 99% confidence will be covering for excess loss.