You gave your customer 30 days to pay, but now 60 days have passed without payment. Maybe there is a dispute. Are your cash reserves running dry because the invoices are not being paid? This guide will look at the importance of worrying about getting paid on time and how you can chase up and avoid bad debt.
Bad debt occurs when the payment of an invoice is estimated to be uncollectible. Bad debt is a contingency that must be accounted for by small businesses that extend credit terms to customers when they issue an invoice, as there is always a risk that payment will not be received.
WHY should I worry about unpaid invoices?
It does not matter if it is your best friend that has not paid you or it is a large corporation. If you cannot collect payment promptly, it will affect your cash flow and profitability, and your business will suffer. This situation is further compounded if you have already paid your costs associated with the invoice, such as materials of wages. Essentially you are lending money to your customer, and if you do not have the cash flow yourself, you may be paying interest on a bank overdraft/loan until this invoice is paid, further eating into your profits.
WHAT can I do to prevent bad debt?
When deciding to offer credit to customers, any action you can take upfront to reduce the chance of bad debt is a much simpler process than collecting money from someone who does not want to or cannot pay you.
To prevent bad debts and protect your business ideally you should:
- Only send out goods or provide services after customers pay their bill
- Provide simple and clear payment options
- Invoice customers quickly and properly
- Give discounts for paying on time or early
- If you intend to provide credit you should research the customer:
- Do an ABN search https://abr.business.gov.au/
- Search ASIC Registers https://www.asic.gov.au/online-services/search-asics-registers/
- Do a credit check (try Equifax, Onedeck or creditorwatch) and ask the customer for references
- Create a business contract with clear terms and conditions using the help of legal advice
- Set up effective payment terms
Have a process to manage payments and debt recovery, a good accounting package will help with this:
- Check contract terms to see when payments are due
- Ensure you have the right contact details
- Contact the customer in writing to request payment
- Keep records of all customer correspondence
- Set up regular payment reminders (some accounting packages will have an automated system for this)
- Telephone the customer
- Send a formal letter of demand
Most important is to create sensible limits on the credit you offer to your customers that they will be able to repay easily.
To prevent bad debts, a factoring company will buy your outstanding invoices from you for a reduced cost and then chase up the debt themselves. It is a fast way to get cash but at a high price as they take on the bad debt risk. (It is unlikely they will not just buy the bad ones)
HOW to deal with bad debt?
The first step is to understand the cause of the debt:
- How long has it been outstanding?
- How much is owed?
- What is the invoice for?
- Is the invoice disputed?
- Is the debtor still trading?
- How long have you been doing business together?
- Does the debtor have a history of late payment, is this different to normal?
- What credit agreement do you have with them and did they sign a Director’s Guarantee?
The sooner you take action to recover your overdue debt, the more likely you will recover your money.
If a customer has not paid you after various attempts, you must decide if the debt owed is worth the additional effort to collect it. For example, $100 is possibly not worth it, but $10,000 is. You must consider your time and cost to recover as well as the likelihood of the debtor paying.
The following avenues can help recover debt:
- Debt collection agencies – will attempt to collect the debt on your behalf for a percentage of the debt owed.
- Legal action – a lawyer can issue a lawyers’ letter of demand or start court proceedings. An online letter service is relatively cheap but going to court is not, however, the recovery costs can be added to the debt. Court proceedings will enforce an outcome and affect a debtor’s credit rating.
- Small claims tribunal – provides mediation and a legally binding solution without having to involve lawyers and courts. Is good for resolving disputes. https://www.accc.gov.au/contact-us/other-helpful-agencies/small-claims-tribunals
- Court – courts will decide on disputes where the amount owed is too high for a small claims tribunal. Consider using a lawyer if your case goes to courts as procedures are more formal and complicated.
- Community legal centres – can assist with letter writing and filling out court forms https://clcs.org.au/
- Small Business Commissioner or Ombudsman – advice on how to recover debts and subsidised or low-cost dispute resolution https://www.asbfeo.gov.au/disputesupport
As a small business, you can also take out Trade Credit Insurance which allows a business to insure themselves against bad debts.
As a business owner, you should consider some sort of provision (put money aside) for bad debts, and this is essentially self-insurance. From an accounting perspective, unpaid bad debt can be an allowable deduction as long as it was included as assessable income in the present or even a previous income year and that it is written off as “uncollectable” in the same year that a deduction is claimed.
Unfortunately, some scammers ask your clients to pay your recent invoice into a new bank account, being the scammers’ account. Ensure your clients understand that you would not change your payment details, and in the unlikely event you did that, there would be a very clear and robust process in writing and over the phone.
If the business you are dealing with is in administration, liquidation or deregistered, they may not have the ability to pay you. Check whether a company is in liquidation or deregistered on ASIC Registers. https://asic.gov.au/online-services/search-asics-registers/
Let your customer know you plan to take legal action or use a debt collector. This may have an effect without the cost.
SUMMARY – fast action to recover debts
If you decide to offer credit to your customers, you can find yourself in a situation where a customer is refusing or cannot pay your invoice. This is known as bad debt. It is best to have a plan to avoid bad debt, but if it occurs, fast action brings the best results. Your best chance of recovery after your efforts have failed is via a small claims tribunal, using a debt collector or the services of a lawyer.