Six Early Warning Signs of Bad Debt
Any supplier of trade credit naturally assumes a certain amount of risk. With commercial debt, balances are higher and so are the risks.
Some potential warning signs may simply be the result of a misunderstanding. But they could also be a red flag for a possible (and expensive) bad debt. Make sure your company is credit-savvy by recognizing the following six early warning signs.
Breaking or Renegotiating Terms
Of course, if your customer simply stops making payments, that’s an obvious sign. A more subtle approach would be when customers try to change the terms of the agreement early on.
This indicates that they may be unable or unwilling to pay you in full within the agreement’s current timeframe. If that’s the case, you’ll want to stay in close contact with the company to determine exactly why they want to change the terms.
Also, if a customer frequently pays its invoices after the agreed payment date, that’s a strong indicator that the company is struggling to maintain satisfactory cash flow. By the same token, exceeding the credit limits on the account is another sure sign that your client is becoming overextended and may soon face difficult financial challenges.
Occasionally reviewing payment terms with your customers is not necessarily a bad thing. It can help them manage cash flow. But if an established customer is regularly requesting an extension of payment days (say, from 30 days to 45), or otherwise seeking changes in the original terms, that could indicate a problem.
Actions speak louder than words when it comes to commercial debt. When a customer is dodging your calls, and messages are ignored, it’s time for action. If a debtor has suddenly become unreachable, you are almost surely headed for trouble.
If the customer’s voicemail is full or the phone is disconnected, you may need to freeze the account and place a warning on your host system for the customer to contact your credit department.
You could pay a visit in person or send a letter, but do it right away.
Returned mail is another red flag. A mail return indicates something has changed, usually for the worst. Mail returns need to be investigated right away to identify a potential commercial bad debt.
Keep in mind that you are not your client’s only creditor. Once a company starts going out of business, assets can quickly evaporate.
Making Partial Payment
If a customer who always pays in full and on time is suddenly making late and/or partial payments, something is wrong. Some customers may not realize that making a partial payment will not protect them from being reported to a credit bureau. Make sure they’re aware of this.
Set a serious deadline for the customer to pay the shortfall, and be prepared to turn the file over to a collection agency if the commitment is not met. Monitor the account closely until things return to normal.
Competitor Requesting Credit References
If a client has been applying for credit with your competition, that’s a red flag. Your customer knows he’s tapped out with you, and is seeking supplies elsewhere. Or perhaps you’ve learned through the grapevine that a previously loyal customer is now buying from a competitor. Either way, shopping the competition is fairly strong indicator that your client has found himself unable to pay you.
And speaking of competition…
Has your customer recently experienced an influx of competitors? A business that has been operating successfully with little or weak competition may be poorly positioned to deal with that. If you notice a number of new competitors in your client’s industry, check their credit report. Even established suppliers may lose a significant amount of their revenue to new competition, making them less able to repay debts.
Finding Unsubstantiated Fault
The business world is rife with examples of customers holding up payment to suppliers for minor or unsubstantiated reasons. A common tactic is to claim that the product was shipped short — for which, of course, they can offer no proof. Or they could contend that there was a defect in the product, or it was damaged during shipment.
One company refused to pay a $10,000 bill because of a problem with a 37₵ item!
Of course, things happen. Product will sometimes be damaged during shipment and what not. But if you suspect subterfuge, that’s a sign of potential bad debt.
High Turnover in Accounts Payable
A/P professionals have a tough job when it comes to answering vendor calls about payments. Pressure from suppliers and internal resources are daily occurrences, even in the best of companies. But if you’ve noticed a different voice answering every time you’ve called your client’s AP department, that could mean they’re having trouble keeping the position filled—another potential red flag.
The worst-case scenario, of course, occurs when staff are expected to perpetuate falsehoods in order to stave off paying vendors. If you learn of these practices, it’s time for a rather unpleasant sit-down meeting with your customer.