How to prevent bad debt during an economic downturn

Shaun Jex | Sunday, Sep 18th 2022
hand holding burning money

Between rising inflation, supply chain disruptions, an energy crisis fueled by international conflict, and rising interest rates, it seems that economic uncertainty is everywhere you look. TD Securities, a Canadian investment bank and financial services provider that offers advisory and capital market services, has predicted that there is a greater than 50% chance that the United States will be in recession within the next 18 months. Against this backdrop, many organizations are assessing how to strategically protect themselves from a potential downturn.

According to Forbes, the average small business has tens of thousands of dollars in late and unpaid invoices. 

An important step toward greater security comes from reducing the risk of bad debt. As companies hold tight to their money, late payments are becoming more frequent — and the longer it takes for an invoice to be paid, the less likely it is that the company will collect the full value.

Craft a Credit Policy 

It seems self-evident that it is difficult — if not impossible — to enforce a credit policy that isn’t clearly defined in writing. Surprisingly, according to Dun & Bradstreet, that is exactly how many organizations are operating. Policies are often treated as “institutional knowledge” with established sales representatives instinctively “knowing” what credit risks to accept and which to reject. Of course, newer employees will have little idea how to operate in this regard, and organizations could find themselves in a legally perilous situation when it comes to holding customers responsible. 

This is why adopting an official credit policy is crucial to help protect your business from bad debts. To reinforce your new vision, it is also a good idea to create a mission statement that encompasses your long-term strategy and includes quantifiable goals such as reducing DSO by X% over a given period of time. 

The next step is putting together a team and clearly outlining what credit responsibilities are associated with each position so that there is no confusion in the process flow. Follow this up by identifying just how your customers will apply for credit and what information they need to supply. 

Determining the quantity of risk your company is willing to take and conducting industry research will help you understand what type of terms to offer customers. When writing the policy, you’ll want to delineate credit limits, provide detailed explanations of customer responsibilities as well as a fully transparent picture of how late payments are handled. 

Improve the Payment Experience

The simplest way to prevent bad debt from cropping up is to make sure your customers receive invoices promptly and can make payments easily. If you are relying on manual and paper-based processes, you’re setting your business up for frustration — on both sides of the equation. 

Businesses relying on manual processes take 67% longer to follow up on overdue payments. 

Slow follow-ups can lead customers to believe that their business and account are not valued. Even worse, the erratic schedule can make it hard to manage their cash flow, not to mention giving them the impression that working with you could be a liability. 

Automation software allows invoice notices to be dispatched immediately. Follow-ups are sent out at regular intervals until the bill is resolved, and can be tailored for specific customers or roles within the company. This helps keep any outstanding debt top of mind and ensures that it doesn’t fall through the cracks.

These communications can also include a link that refers customers directly to a self-service payment portal, another element in improving the payment process. Customers need the ability to pay at their convenience, without having to spend time calling your team or sending out physical mail. A self-service portal allows customers to log in, view relevant account activity — such as open invoices or credits available — and make payments with a few easy clicks. The portal also allows them to pay via their preferred method — credit card, ACH, or wire transfer — and immediately raise disputes or ask questions about an invoice. The issue will automatically be routed to the appropriate member of your team for a quick resolution.

Create Effective Dunning Letters

With 93% of organizations stating that they experience late payments, another step in preventing bad debt is to develop a comprehensive strategy to handle a situation where a customer is unwilling or unable to pay an invoice. 

Dunning letters are formal communications that clarify the outstanding debt, payment deadline and potential penalties for failing to comply. Because a dunning letter may be used in legal proceedings, it is vital that they include an attached copy of the original bill with invoice number, date, and total amount due, as well as information on any fees or interest charged as a result of the delayed payment. 

Typically, dunning letters are sent out at 30, 60, 90, and 120 days past due. It’s also a best practice to follow each letter with a phone call. This will help you ensure that the original invoice was received, and allow the customer to ask any questions they may have. 

Automation can help the process by allowing you to schedule when these notices will be sent out, and by keeping a complete record of communications. 

Each of the above steps can reduce the risk of customers defaulting on debts, helping keep your cash flow healthy and your business secure, even when facing external economic factors.