Tax & admin · 12 June 2017

What is bad debt and how can I avoid it?

What is bad debt?
What is bad debt?
Here, Emily Coltman, chief accountant to FreeAgent, draws onher expertise for Business Advice readers to answer one of the most important questions for new founders what is bad debt?

If you’re new to business or are thinking about starting up on your own one hazard you may have heard of is exposure to bad debts.

But what exactly are these, and how can you protect your business from them? Use the below tips to minimise your business’s bad debt risk.

What is bad debt?

Simply, a bad debt is when one of your customers doesnt pay your bill. A doubtful debt is when you think a customer might not pay a bad debt is when they definitely won’t pay, for example they dispute the bill or theyve gone out of business.

Bad debts are bad news, because they mean your business has less cash than you planned for, and may not be able to afford to pay its own bills. In the worst case scenario, bad debts can make you go out of business, too.

How can I reduce the risk of bad debts?

Here are some tips for avoiding, as far as possible, bad debts in your business.

  1. Do not have just one large customer
I have seen businesses which have only one customer, and that customer is a very large business – and unfortunately large businesses are notorious for paying their smaller suppliers late.

If you only have one large customer, what happens if that business switches suppliers, or goes out of business? Your business will have no further supplies of cash and is at very real risk of having to stop trading.

don’t risk it spread your services!

  1. Do your due diligence
Before you take on a big piece of work for the customer, check them out. Look at their accounts on Companies House or DueDil if their business is a limited company, and see if their business is solvent in other words, if the total sum at the bottom of their balance sheet is positive. If this figure has a minus in front of it, that is not good news!

Look on social media, especially Twitter, to see if there are any queries to them from suppliers who havent been paid.

  1. Ask your customers to sign payment terms
Before you do any work for your customers, present them with a one-page summary of your payment terms, including how much you expect to be paid as the project progresses, and when payment is due.

Make sure this includes a clause that says that if payment is late, you will stop any further work until payment arrives. Do not start any work on your customer’s project, or deliver them any goods, until the customer has signed this page to say they agree it.

  1. Take payment up front

 
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ABOUT THE EXPERT

Emily Coltman is chief accountant to FreeAgent, provider of cloud accounting software for freelancers, micro businesses and accountants. She is passionate about helping the owners of small and growing businesses to escape their ?fear of the numbers? and she translates small business finance and tax into practical common sense speak.

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