In business, sooner or later customers or clients will owe you money and will be unable to pay. You can blame your customer, but in some sense, you may be partially at fault. Here are a few tips to avoid (or at least minimize) bad debts in your business:
- Your Business is not a Bank. If you supply goods or services used in your customer’s business, do not allow your customer to benefit from what you have supplied (by using it or reselling it) without paying as agreed. It is very common for sellers and re-sellers of goods to use trade credit as a private piggybank. They purchase your goods on credit, re-sell them at a profit, and use the proceeds of sale to finance a certain lifestyle. You need to find a way to make sure that when your customer gets paid, you get paid as well.
- Monitor Your Receivables Closely. This should be done religiously. Note changes in customer payment patterns. When you see a customer who normally pays within 10 days suddenly extend his payment pattern to 30 days or more you should be concerned. A well run business monitors its receivables on a daily basis. If you see your receivables creeping up disproportionately to sales increases, it is a sign that your customers have changed their payment pattern. Be prepared to discontinue sales to customers who do not pay as agreed and/or cut off the availability of trade credit to slow paying customers.
- Offer Early Payment Discounts and Enforce Late Payment Charges. On the one hand, you can encourage customers and clients to pay early by offering a discount for prompt payment. A discount between 2% and 5% for payment within a few days is not uncommon. On the other hand, consider enforcing late payment charges for bills that are not paid as agreed. Make sure that late payment charges are disclosed in your billing; typically a customer invoice will say something like ‘balances not paid in full within 30 days subject to a late charge of __% per month.”
- Require Personal Guarantees. Nothing beats a written personal guaranty for keeping corporate and limited liability customers honest. Banks will rarely advance credit to small businesses without a personal guaranty from the individual owners. Why should you?
- Other Types of Security. If you are a seller of goods, you should consider retaining a security interest in your goods through filing a UCC lien against your customer. A security interest can also be taken in inventory and other personal property. Collateral mortgages can be taken in real estate to secure business trade debt. While we recommend that suppliers try not to become the bank for their customers, they should think like a bank when it comes to obtaining security for trade credit.
- Know Your Customer. Our final suggestion is perhaps the most important one. Get to know your customer. Thoroughly investigate the individuals connected with your customer’s business. The internet provides a wealth of information at the click of a button to find out if your customer has ever been involved in litigation or if the business has ever been in the news. You would be surprised to learn how many small businesses move from supplier to supplier, leaving a history of unpaid bills, lawsuits and bad publicity. Check out your customer carefully to avoid becoming the next victim.