In a perfect world, suppliers would prefer to be paid cash up front. However, in reality, the world works on credit. Trade credit is inevitable and so is the debt that comes with it.
For most businesses, trade credit is essential for growth as businesses don’t have to pay suppliers on the spot but rather with agreed payment terms, usually in the form of a 14 or 30-day invoice. The same is true for their suppliers, credit is the preferred payment and a business might lose customers to competitors if they demand cash upfront or on delivery.
If an invoice is paid within terms (by the due date), then the debtor remains in good standing with their credit and the creditor is happy. However, this reality is also harder to come by these days.
So, when does good credit become bad credit?
The answer is pretty straightforward. As soon as the payment is overdue, it becomes a debt that is worse than before. The longer the debt is overdue, the harder it becomes to collect it. Statistically, a 60-90-day overdue invoice is about 73% harder to collect. A 6-month overdue invoice has less than a 50% chance of being collected.
For SMEs, using a debt collector can be an expensive process and often, it feels easier for the debt to get written off. However, the damage has been done and the debt doesn’t go away.
What does a bad debt ultimately cost you?
The debt, in turn, affects cashflow. The example below provides the bigger picture of how bad debt affects cashflow and business:
Debt amount is $10,000
Profit margin = 10%
Additional sales required to make up for the $10,000 loss = $100,000
It’s no wonder that 90% of Australian businesses fail from cashflow problems. According to a Xero Business Insights report, more than half of business owners worry about cashflow each month. CreditorWatch’s Quarter 1 2018 Small Business Risk Review showed that conditions worsened during summer holidays and payment defaults worsened in comparison to last year.
Bad trade debt becomes a vicious cycle or like a game of janga.
What you can do:
- Create stricter payment terms with your debtors from the start
- Learn the red flags to look out for
- Perform a credit check and monitor new and existing suppliers and customers
- React immediately to any adverse information that is flagged (ie. Bankruptcy, defaults, court actions). Have a proactive plan in place.
- Warn other businesses and register bad debt on a platform like CreditorWatch
- Run your debtor list through a datawash so that you can see current risky suppliers and customers
- Integrate your XERO/MYOB accounts for easy monitoring and credit reports for each new contact you add
A bad debt can affect both parties’ credit. Don’t wait until it’s too late to be vigilant and take action.
Protect your business from bad credit and sign up for a free trial with CreditorWatch.
Attribution: When Good Credit Becomes Bad Credit