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October 3, 2023

How to Avoid Bad Debt

Daniel Berlind
CEO

Navigating the business world carries its fair share of challenges, and one of the most daunting is the threat of bad debt. When customers or clients fail to meet their payment obligations, it creates a ripple effect of financial strain that potentially jeopardizes your business’s stability and sanity.

Luckily, bad debt doesn’t have to be an inevitable part of your business. You can minimize the risk of bad debt with strategic planning, astute financial management, and the right tools. In this article, we’ll explore what bad debt looks like and provide practical strategies to help you steer clear of it, safeguarding your business’s financial health. Let’s jump in!

What is bad debt?

First things first, let’s understand what bad debt really is and how it differs from good debt. Simply put, bad debt refers to money customers owe that is unlikely to be paid back. It typically occurs when they are unable to pay, refusing to pay, or going through bankruptcy.

Good debt, however, is an investment that can help your business grow and generate profits. For instance, borrowing money to expand your business, improve operations, or invest in new technology can be considered good debt because it can potentially boost your bottom line in the long run.

Examples of bad debt

Before we move on to tips for avoiding bad debt, let’s take a quick look at some common examples of it:

Unpaid invoices: When customers don’t pay their invoices on time or at all, it can lead to bad debt.

Unpaid rent: When tenants don’t pay their rent on time or at all, it’s considered bad debt.

Overdue accounts receivable: If customers consistently delay their payments, it can impact your cash flow and result in bad debt.

High-risk clients: Sometimes, you may offer credit to clients with a history of financial instability, increasing the chances of bad debt.

Forgotten debts: Business owners often fail to follow up on outstanding debts, which can eventually turn into bad debt.

Leading causes of bad debt

Nobody wants to experience bad debt, so why does it persist? Understanding its main causes can help you address potential issues proactively.

Poor financial management: Inadequate financial management can lead to errors in billing, collection, and debt tracking, increasing the risk of bad debt.

Economic downturns: During tough economic times, customers may face financial hardships, making it challenging to fulfill their payment obligations.

Lax credit policies: Loose credit policies without proper risk assessment can result in extending credit to high-risk clients, leading to bad debt.

Ineffective communication: Lack of communication with customers regarding outstanding debts can lead to bad debt, as customers may assume you no longer care about the payment.

Strategies to avoid bad debt

Now that we know what bad debt is and the pitfalls associated with it, let’s explore some effective strategies to avoid it.

Thorough credit checks

Conducting credit checks is a great place to begin. Before extending credit to customers, always perform these checks to assess their financial stability. This step can help you identify potentially risky clients and make more informed decisions.

Outline clear and concise payment terms

Ensure your payment contract is transparent, easy to understand, and communicated clearly to customers. Setting expectations from the beginning helps reduce the chances of disputes later on.

Encourage early payments

Depending on your type of business, you can offer discounts or incentives for customers who pay their invoices early. You’ll get your money on time and strengthen your customer relationships in the process!

Send invoices immediately

Promptly sending out invoices is another way you can avoid bad debt. Set a reminder or create a process to send out the invoice as soon as the service or task is completed. It doesn’t hurt to consistently follow up on any outstanding payments, either. Sometimes a friendly reminder can make a big difference!

Combatting late rent payments

You can implement a few measures in the event of a late rent payment. First, clearly outline when the rent is due and when the grace period ends in your lease contract. Next, if they miss the initial due date (before the grace period ends), send a reminder email letting them know they haven’t paid and how long they still have to do so. Finally, if the grace period is over, you can remind them a final time and tell them they will also have a late fee. Most property managers will do anything to avoid bad debt and evictions, so implementing these follow-ups can be a game changer.

Incorporate fraud detection

Another great way to prevent bad debt is to implement fraud detection into your processes.  Platforms like Snappt are designed to detect fake bank statements and pay stubs, which are typically indicators of financial risk. By catching these fraudulent documents during the screening process, you prevent potential bad tenants from residing in your property. As a result, the likelihood of bad debt decreases!

Lastly, Don’t forget to review your credit policies and adjust them as needed on a regular basis. If you notice a spike in bad debt, it might be time to tighten your credit terms.

To Sum Up…

Bad debt can be a significant roadblock for businesses, hindering growth and financial stability – but it doesn’t have to be. By adopting smart credit management practices, staying vigilant, and addressing potential issues promptly, you can steer your business toward a debt-free future.