Small business: Steering clear of bad debt

Eighty per cent of bad debt comes from companies that you have been working with for more than a year. Photo / Thinkstock

Dun & Bradstreet New Zealand General Manager, John Scott on how to avoid slow paying customers.

How does bad debt, no matter how small, affect a small business?

Bad debt can be a particularly painful experience for small businesses, as they typically have fewer liquid assets and tighter cash flow than their larger counterparts. One of the most important steps you can take to prevent late and non-payment from happening in the first place is to conduct a credit check on a potential customer before extending them credit, as this can give you an idea of their ability to pay on time. You should also consider credit checking existing customers, as 80 per cent of bad debt comes from companies that you have been working with for more than a year.

With so many small businesses providing goods and services on credit, it has become all the more imperative to determine the level of risk associated with their customers. Some customers that appear to be creditworthy may in fact have defaulted on their payments or are already mired in debt.

Doing a thorough credit check through a credit reporting agency such as Dun & Bradstreet can reveal information such as bankruptcy, court judgements, defaults and past credit enquiries, all of which can help you make an informed business decision.

Because NZ business is all about relationships, it makes it even harder to try and pressure customers for payment. What do you advise?

Chasing up late payments is often an unpopular task with many business owners for a range of reasons, from a lack of experience through to a fear of damaging important client relationships - but it is still a necessary part of the accounts receivable process. To reduce the risk of damaging your business relationships, there are two main things to consider: the number of days the invoice is overdue by and the reason for non-payment. These two factors will determine your approach to collecting an overdue debt.

For example, if an invoice is five days to a week late, assume at this point that it has been somehow overlooked. The appropriate action here would be to send them a gentle reminder but if there is still no response and the bill continues to age, consider picking up the phone and engage them in a polite but firm conversation.

If the debtor is unable to pay due to financial stress, a payment plan can be arranged but ensure that you thoroughly research their financial position yourself to determine if this is true. If an invoice is 60 days overdue, you may want to consider referring the account to a debt collection agency.

How long do NZ companies generally take to pay their invoices?

According to trade payment data, the length of time businesses take to pay their bills, in the June quarter 2012, firms with less than 20 employees took 41.1 days to pay their bills.

Trade information is one of the best indicators of cash flow and business health, as it reveals how a firm is meeting its existing financial obligations and can provide insight into future payment patterns. Reported monthly, trade data is generally regarded as the most predictive factor in assessing a firm's credit risk and risk of failure. In particular, trade data is the most predictive element in small business credit scores. More often than not, it is the only commercial credit information available in the absence of a banking relationship.

How can you monitor your customer portfolio so you can be alerted to early warning signs of financial trouble?

It is crucial to check your customers' financial health at every stage of the credit life cycle and not just at the outset of the business relationship, as changing market conditions can affect a firm's ability to pay. Regular monitoring can alert you to early warning signs of financial trouble, such as an increase in delinquent accounts, court actions and collection notices or other factors that contribute to the overall risk score of a business.

The risk of delinquency can also be minimised by undertaking a regular review of your credit terms - if they are too long, it means that you are waiting longer to be paid. While 30 day terms are standard for most high-transaction businesses, you may want to reduce this to seven or 10 days if you don't have large reserves of cash.
Regularly updating your credit terms to reflect your risk appetite will help you get paid on time and avoid any financial trouble down the track.

Every small business with a product to sell is talking about it on social media but how effective is their online chat really being? Our experts will give some tips next week on how to optimise what you do online. Tell us your stories of successes and failures. Please email me, Gill South, at the link below.