How to avoid a B2B debt collection process — This step-by-step guide illuminates the Best Strategies for avoiding bad debt in business.
It’s not uncommon for retailers to ask for additional time to pay their invoices. However, if retailers can’t pay, that puts bad debt on suppliers’ books. Research shows that more than one-third (36 percent) of accounts receivables (A/R) departments write off up to 25 percent of their receivables as bad debt each year.
During an economic recession, suppliers are in an even more precarious position: retail revenue is down, and retailers may be more likely to lapse on payment terms in the months ahead, passing along large amounts of bad debt to their suppliers.
How to avoid a B2B debt collection process — This step-by-step guide illuminates the Best Strategies to Avoid Bad Debt.
What is Bad Debt Expense?
When a customer defaults on its bills or is in danger of doing so, the company extending credit to that customer faces a bad debt expense. Bad debt expense reflects the amount of accounts receivable that a company is unable to collect now and may not be able to collect in the future. Because this bad debt expense must be charged against the company’s accounts receivable, bad debt expense reduces the amount of accounts receivable on the company’s income statement.
There are many examples of companies dealing with bad debt expense. One company changed its approach to bad debt management after two major clients defaulted on their bills, leaving the company facing tens of thousands of dollars in losses. To make matters worse, the company had also dedicated considerable staff time and resources trying to collect on those bad debts with no success. By purchasing credit insurance, the company not only protected itself against future losses from bad debt, but it also was able to leverage that protection as it pursued growth with new customers.
Another company that was growing rapidly,, grew concerned about its exposure to potential bad debt expense as its customer base expanded. In the past, the company knew all of its customers either personally or by reputation. However, as it grew, the company recognized that it could not eliminate the risk of bad debt expense entirely. It had so many new customers coming on board that it had to evaluate their creditworthiness via third party data and information that did not always provide an accurate picture of a customer’s financial state. Johnstone Supply ultimately decided to purchase credit insurance to reduce its exposure to bad debt expense.
1. Thoroughly vet new retailers.
Complete thorough credit and business checks using trustworthy, third-party resources like Experian, Transunion, Equifax, and others. In addition to these sources, use insights from both current and predictive customer data that can reveal how a retailer’s business financials have been impacted and for how long revenue may be affected. Then, widen the scope and examine industry data for a more comprehensive view of the retailer’s financial health. Together, these methods accurately assess your customer’s ability to keep invoices current and mitigate the risk of fraudulent activity.
2. Rightsize credit lines.
Review customer credit lines. If the credit line is far in excess of monthly purchasing requirements, reduce it. This prevents retailers from overextending and encourages prioritizing payments to keep balances low — reducing days sales outstanding (DSO) without inhibiting purchasing. For example, if a customer qualifies for a $200,000 credit line and purchases less than $50,000 each month, offer a $100,000 credit line instead.
3. Create and enforce strict payment terms.
Communicate clear payment terms and make them easy to find on your website or portal. You can also adjust payment terms if needed based on a customer’s payment history. To further encourage prompt payments, enforce penalties for late payments and reward those made on time. More importantly, stick to the terms you set. You can always review terms later once the retailer proves trustworthy or their financial situation improves.
4. Decrease disputes with accurate invoicing.
Thirty-nine percent of A/R teams said 26 percent or more of their late payments are due to a dispute. To limit disputes, make sure invoicing is prompt and accurate, and that line items, tax calculations, banking information and customer addresses are correctly listed. Sending, creating and receiving invoices manually introduces error, especially when A/R teams have a high percentage of unique customer billing requirements. If this is a recurring problem causing disputes, consider investing in A/R automation to reduce error.
5. Outsource A/R for high-value accounts.
A payments partner can handle all of the above strategies — assuming credit risk, extending credit on your behalf, performing thorough credit checks, and offering digital invoicing options. This not only reduces the risk to working capital should retailers fail to pay, but frees up time for your A/R team to focus in other areas. Even more, an added layer of top-tier customer service provided by a partner can expertly guide high-value customers through the payments process.
As a supplier, maintaining customer loyalty and encouraging repeat purchases is critical — but so is protecting your bottom line. These five strategies can help you achieve that mission and keep finances secure. Bad debt is always a risk when extending terms, but if managed well, you limit that risk and take better advantage of the benefits of net terms.
6. Have a credit policy and terms of trade in place
Many businesses supply goods and services on the basis of informal arrangements. Unfortunately this means that disputes often arise that could have been avoided if there had been clear, written terms of trade from the start. Having clear terms of trade is an excellent way of minimising and preventing bad debts.
Make sure you complete thorough credit history and business reference checks before you offer credit to new customers. Clearly articulate to your customers up front, in writing, your terms and the credit limits (so they know you are serious about your collection program) and ensure that they sign acceptance of your terms. It’s important that all your staff understand and follow this credit policy.
If you decide to implement new payment terms and conditions, begin with new customers or customers who wish to extend their credit limit. You may find it more difficult to introduce new terms to existing customers, especially those who have been loyal in the past or who you know personally and don’t wish to upset!
7. Provide the right information on quotes, invoices and statements
If you provide the right information on your documents, and invoice promptly, you are more likely to be paid on time.
All quotes, estimates, invoices, contracts, agreements, purchase orders, and related documents should refer to your terms of trade and credit policy. Invoices and statements should show clearly:
- the amount owed
- the payment due date
- the billing address
- your bank account details.
Include any extra details that a customer might need, such as the purchase order number, contract/account number, and details of who placed the order. If necessary, contact the customer before billing to check exactly what information they need to expedite payment.
A good way to discourage late payment is to show details on your invoices and statements of the collection charges you may apply to overdue accounts.
8. Make sure your systems are up to date and monitored
The secret to best debtor management system is well-maintained information. There are many software solutions available to help you with your credit management, and increasingly more of them are cloud-based. Good software solutions can relieve you of much of the administrative and management pain associated with debtor management.
The best way to minimise issues is to monitor your debtors ledger closely – by keeping close track of the days outstanding you’ll be able to spot adverse trends and take prompt action before they start to have an impact on your cash flow.