Prevention is better than cure: avoiding bad debt before it gets ugly

small business knows that at the core of running a small business is getting paid. This is particularly relevant in current economic downturn of Covid19 causing business cashflow to drop dramatically.

In an ideal world as a small business owner you’d like to think that you can send invoices and be paid relatively promptly. The reality is that for a variety of reasons this doesn't happen, and bad debt need needs to be avoided by active debtor management.

Here’s my key tips on avoiding bad debts

• The foundation is getting your initial contract, terms and conditions or supply agreements right. Your contracts, terms and conditions or agreements must protect you. They must have enough detail to identify the debtor. Too many times have I seen hastily filled out supply agreements which only list an ABN or business name, which is not enough to properly identify the debtor. If you are dealing with a company debtor, an ABN and contact name is not enough - you need the company number and name.

  For larger debts, you should must get directors guarantees to pay or bank guarantees, or security interests over property or goods.

  Reconsider your payment terms. Do you require payment in 7 days, 14 days, cash on delivery, payment before you commence work? Do you charge interest? Do you give a discount for paying early? If you offer credit, how do you assess the risk of the debtors? There is no easy answer to these questions and they are best addressed by sound legal advice about what is in your businesses best interest.

• Put the resources into making sure debtor management is central to your business. Have a system that:

  • Maintains good records of the agreement/contract/terms of service
  • Sends invoices promptly
  • Tracks bad debts by reviewing your debtors weekly or fortnightly.

• Have a procedure for reminding debtors and contacting debtors. Your reminders should start with a statement of account which is followed up by reminders. Reminder letters can increase in frequency, tone and urgency as the time that payment is overdue increases. For large debts, early on you should seek advice from a lawyer about taking court action to recover the debt.

• Making sure your debt collection doesn't amount to harassment, which is prohibited and subject to penalties. Debtor harassment includes contacting someone everyday demanding payment or mis-stating the consequences of not paying eg 'you'll go to jail' or 'we'll bankrupt you'. Your staff need to be trained to know the law and what they can and can’t do — a starting point is the competition regulators Debt collection guideline: for collectors and creditors. Breaching this can result in being sued for compensation.

• Be careful outsourcing your debtor management to debt collectors. As your agent, you can be liable for some conduct, or you can be implicated in poor debt collection conduct impacting on your business brand and goodwill.

The best way to avoid bad debt, in my experience, is to put time and effort into really strong preventative measures.

At OFRM we advise businesses about a process for ensuring your business is paid, reducing bad debt and complying with the law when contacting clients and asking for money. Contact Lachlan Edwards on 0427 916 442 or Siobhan Liston on 03 5445 1067.