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How to reduce your chances of a Bad Debt - What do you do if you are asked for extended credit?

The following article is aimed more for businesses with a turnover under £10m.

Firstly, I do want to say I am, no expert in Credit Control. What has prompted me to write this and spend most of my weekend, on this inexpertly written article - is - I find it very sad, when Company Directors speak to me about “bad debt” and the terrible consequences it has for everyone connected with the business and of course the “Domino Effect”.

I have written this from my conversations with Company Directors and various professionals over the years.

What happens when a company is asked to give extended credit terms?

The first question that is normally asked is how much is the debt?

Let us say the figure is £50,000, the next question might be, have they already extended their credit period, and/or when is it due?

In some instances, a company director will decide quite rapidly or on the hoof, as some put it (it is the consequences of rapid decision making that that has prompted me to write this).

The credit controller might say its ABC company they've been with us for some time let's give them some extra time (but how many businesses said that about Carillion, BHS, Toys R Us and another 100 examples? And boy did they regret that).

They might think to themselves, what can we do, they have said they will pay us in another 30 days?

On a personal note I tried very hard to warn every client that I spoke to about one of the above and they all said to me “Mark, we have been dealing with them for ages they do pay late, but I'm sure we will be paid” It’s always easier to think that, is it not?

Some business owners will ask some questions give the matter some thought and then come back with an affirmative or some sort of acceptance of a delay in payment, they might not even speak to the client, just tell the accounts department to give them another month.

However, if a finance company was being asked to lend £50KI would expect them to ask for the following;

  • Last 3 to 6 months bank statements
  • They would look to see if there were any unpaid items, whether the business was in a time to pay arrangement with HMRC and they would assess whether the cash flow was getting tighter.
  • Latest management accounts
  • Last set of full accounts
  • They might be asked to explain briefly, why they are a good proposition to lend to.

And they would do a full credit check on the company and possibly the directors.

They would then decide based on their lending criteria and their years of experience in lending to businesses, whether they would support the business and what terms they would want back.

Short term loans to businesses, with a poor credit rating, can expect personal guarantees and an interest rate of 20-30%.

Compare this to how a company director makes his decision, and experienced underwriters know they will get it wrong, that it is why they might charge 25% interest.

The real underlying question which many do not ask themselves is what effect would it have on our cashflow if we found out that 50K that we had expected in, was not going to come in at all?

By unexpectantly agreeing to extended credit terms, without a detailed review of the business, some might say is asking for trouble.

The information requested by a finance company is all easily available and can be supplied by a business in 2 hours if they wish to.

To recover £50k, a business would have to additionally fund and complete a new order or increase their turnover by £200k if the margin is 25%, this will be in addition to current work and that would be without overtime or extra costs and being paid for the extra work.

In many circumstances the companies that are hit with bad debts are the ones that asked fewer questions and took an easier line on the problem, they will be last in line. The businesses that take a tough stance over their terms are paid first.

But perhaps we ought to take some other things into consideration.

Why are they asking us and not another supplier?

The chances are, they will be behind with several other companies, so why are they asking me? Is it because they think I'm an easy touch or they have been refused elsewhere?

It is human nature to go to who they perceive will be the easiest to get a yes from, the business with the easiest to deal with accounts department, is a good place to start, for extra credit.

The other question one might consider is why are they asking us and not a finance broker or going direct for finance?

And before a company extends their credit terms one might hope the director reflects on what happens when a company goes into liquidation, because they might take the company down with them?

A prime cause of liquidation is bad debt.

Everyone connected with a company, rely on directors to run their business efficiently and not leave them behind unpaid or work not completed.

Employees and their families have the same reliance.

Then of course there are the director’s own families, who rely on the benefits the business provides, they will not want to see their lifestyle change for the worse and their income cease.

The frightening thing about a company going into liquidation is the speed that it can happen, one month the company is trading well and then suddenly the following month, expected cash does not arrive.

Your staff start to worry, this is filtered through to your customers/clients and a downward spiral, just occurs overnight.

Rumours start circulating, credit is denied whereas normally there would be no issues, company’s stop paying because they hear the business has bad debts and are running out of cash.

Perhaps the question a company director should ask is, can we afford to write out a cheque today for £50k without damaging our cashflow?

To prevent this question occurring at all, they could review all procedures in accounts or credit control.

These are some of the procedures that Company Directors use.

The accounts department checks when every invoice is sent out that it is correct, and payment will be made by the due date.

A follow up letter is sent, confirming the invoice will be paid by due date.

If the accounts department are asked directly, for a longer payment time or any type of arrangement.

They will have a set agreed upon response, such as.

“I cannot authorise any added time or variation of payment at this level of invoice, a full proposal and the reasons behind the request would have to go to the Company’s Accountants for approval, and then it will be immediately put to the Directors and Shareholders”.

The businesses in most danger is when 30 days becomes 60 days and then extended credit is asked for.

Some clients do take 60 days to pay and it is a decision by the Directors to allow this, but if credit control start allowing other businesses to fall into this category, the risk of bad debt will rise.

I am told the client invariably never asks again, when they know the request is going to be taken so seriously and that they will have to provide potentially embarrassing information.

The assumption is they go to a softer target, to obtain help to finance their business.

Recommendations appear to be as follows.

  • Review all debt collection procedures
  • Go though your debtor list on a weekly basis
  • Have a detailed prescribed response and procedure for any request for a delay in payment

If just one business owner, reads this and shows more caution and thinks what would happen to us if £50k was taken out of their cashflow, before just saying yes, then I will be a very happy man.

P.S If your business has been hit by a bad debt, you are very welcome to give us a call on 0800 612 5364.

If you think you might need some finance to cover the bad debt you might consider this.

To achieve the best interest rate when applying for finance try and apply as early as possible and not when you really need it.

Finance companies ask to see your last 3-6 months bank statements, and if they detect your cashflow deteriorating the interest rate will increase. The worst effects of a bad debt, typically are not felt immediately.

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