How small businesses can prevent bad debts from the outset

Debt, financial obligation or money to pay back to creditor concept, miniature businessman standing and thinking on cube blocks with alphabet building the word Debt on bank account statement with pen.

Poor invoicing practices are systemic in Australian business culture. Late payments, bad debts and write-offs are an unfortunate yet seemingly inevitable reality of doing business. However, it’s the small business owners who suffer the brunt of these bad habits.

Cashflow bottlenecks cause a strain on resources, leading to long-term damage for SMEs. Research by Xero shows that small businesses that are consistently paid late grow their revenue at three-times a slower rate than their paid on-time counterparts. This creates a knock-on effect, as late payees tend to pay their suppliers an average of eight days slower, falling deeper into the cycle of debt. It should come as no surprise then, that almost a third of small business owners estimate their company to have over $20,000 in outstanding receivables at any given time.

There is no rulebook for how to manage late payments and debts, and unfortunately for small businesses, they don’t always have the resources or customer base to fall back on when a debt goes bad. That’s why it’s so important to prevent debts from the outset – here’s how:

Take a “buyer beware” approach

As a merchant, it’s in your best interest to be discerning about who you choose to do business with.

With the recent changes to bankruptcy law, it’s never been more important to conduct pre-transaction due diligence on the financial health of a potential customer.

Perform a credit check before engaging in any kind of agreement to see how a business is trading; this will minimise the risk of being left with a written off credit, should the company collapse.

Be diligent about the details

A significant cause of debtor disputes can be attributed to poorly written contracts, particularly when it comes to invoicing terms and agreed-upon deliverables.

Of course, the nature of your customer agreements will differ for every business; however, it’s essential to be crystal clear on your trading terms and communicate them in writing across all quotes and invoices. This can include a statement explaining that if a debt remains outstanding past the trading terms, your company reserves the right to engage a debt recovery agency, and that any fees associated with the debt recovery will be passed on to the debtor.

If you’re unsure how to structure these agreements, it’s worth consulting a lawyer to build a flexible template to work with. Creating watertight contracts is your best protection against debt, so be diligent about the details – it will pay off in spades.

Learn from your late payers

If you find yourself continually chasing the same customers over late payments, it’s time to come to a new agreement.

Consider enforcing stricter invoicing terms for repeat offenders, such as a pre-payment of your service or goods. It’s also worth looking into technology platforms that enable alternative payment methods, such as automated Direct Debit, to ensure prompt payment on your agreed-upon date.

Ultimately, if your customer refuses to be flexible in finding a solution to their poor invoicing practices, you might need to consider re-evaluating your business relationship. Sometimes, the best method of prevention is learning when to cut your losses, even if that means losing a customer.

David Rennex, CEO and Co-Founder, DebtForce