Many businesses will offer money to their customers and clients, in the form of credit. This is basically a loan that is paid back over a set time period, either with or without added interest. The idea of debt can be off-putting for many but it’s a vital part of business and can both attract customers and increase profits.
However, it should be kept in mind that there are two types of debt, good and bad. Good debt is repaid, on time without any problems. Bad debt is debt owed by a customer or client that cannot be retrieved and therefore leads to a loss for the business. With this in mind, what are the best methods for avoiding bad debt?
Screening
One of the most effective ways to avoid bad debt is by ensuring you are lending to clients and customers who will pay it back. This pre-emptive approach allows you to avoid bad debt before it happens, saving you much needed time and money in the long-run.
When it comes to customers or clients, a thorough screening phase will give you a good idea of whether they are desirable applicants. In terms of customers, this includes background checks, credit checks and questionnaires, all of which will flag any past debt problems. Income information is also important as it will showcase whether the applicant realistically has the means to pay back the debt.
With clients, the process is slightly different as you most likely be working with another organisation, as opposed to an individual. Credit checks and background checks are also applicable but you should include research in to the organisation, including the company website and social media.
It may be beneficial to mock up a “perfect” candidate profile, including all their desirable characteristics and then refer to this when judging potential borrowers.
Terms and Conditions
Businesses can protect themselves by drawing up a comprehensive list of terms and conditions, agreed upon by both parties. The more aspects of the agreement that are set prior to the loan, the more straightforward the process. This is the time to decide on the return payment plan, including the cost of instalments and the regularity of payment. This is also where you decide on levels of interest, if applicable.
Probably even more important, when attempting to avoid bad debt, terms should be made on what happens if a payment is late. How long will the client be given before steps are taken further, for example penalties and legalities. These are terms which will do the most to dissuade clients from creating bad debt.
The agreement should be drawn up as a written contract, read and understood by both sides and signed before the loan is made.
Enforce
A mutually agreed upon contract is a good first step but the only way to safeguard against bad debt is to actually enforce the contract. Continually assess your clients and customers and use this information to make informed decisions. For example, if a client is making their payments regularly and on-time, you could increase their credit limit. Conversely, if someone is making late payments or no payments at all, you should look at reducing their credit limit or even enacting penalties.
Communication is key, throughout the entire process. If you are seeing warning signs from one of your clients, this is the time to get in touch and check in. Sometimes a late payment is a one-time mistake and you can give the benefit of the doubt. Obviously, in other cases it’s the start of a pattern and there should be formal communication on the potential penalties if the client continues to miss payments.
Being open to communication is also important. There can be disputes that arise throughout the process and if your clients feel like they aren’t being listened to, this can have a negative effect on their dedication to the payment plan.
Outsource
Unfortunately, there comes a time when the only option left is to outsource to a debt collection lawyer or agency. This the nuclear option and should only happen after you have exhausted all other methods. Thankfully, upon being notified of debt collection, many clients will realise how serious the situation has become and become much more cooperative. Of course, this doesn’t always happen but that’s when the debt collectors and courts will get involved.
Bad debt can be extremely damaging for a company, particularly smaller businesses. However, there are ways to avoid it, as well as ways to retrieve this money, should the worse happen.
