The Effects Of Bad Debt On Small Businesses
A recent survey revealed that 65 percent of debt recovery experts saw an increase in bad debt collection activities among SMEs over the past 12 months. The survey also showed that a little over 36 percent of businesses took at least 6 months, sometimes longer, to recover an entire debt. The conclusion, unsurprisingly, is that past due invoices often limit or stifle a SME’s ability to operate at full capacity and serve its customers. To explore the reasons for this, let’s look at 5 of the most heavy hitting impacts of bad debt.
Bad Debt Reduces Cash Flow
Cash flow directly affects a SME’s business operations. Each month, overhead expenses, such as office supplies and materials, utilities and building lease payments must still be paid. Staff must also be paid on a regular basis. While large-sized businesses may feel the effects of bad debt, SMEs will often feel the strain at a much higher intensity due to the lack of financial resources.
Bad Debt Reduces Motivation Among Owners and Staff
When customers don’t pay, both business owner and staff may become less motivated to do their jobs. Staff, in particular, may lose their motivation and wonder about their job security. The concern is real, because in severe cases, layoffs may occur if bad debts are not collected in a timely manner.
The Stress of Bad Debt Can Manifest Physically
In addition to the psychological effects, stress can have a physical impact on the business owner. A lack of sleep and improper eating patterns may result from working long hours trying to increase cash flow and ensure that the business is able to continue.
Bad Debt Distorts Business Focus
A bad debt crisis may cause SMEs to lose focus on core objectives. The main goals of most businesses is to deliver needed products or services to its existing customers and to acquire new customers. To accomplish this, an allotted amount of time has to be set aside for servicing existing customers. Time scheduled for marketing and proposal writing to acquire new customers is also important and setting aside the appropriate time is difficult to do if the primary focus has shifted to debt recovery efforts.
Bad Debt Jeopardizes Tax Payment Obligations
Bad debts can also make SME business owners more susceptible to missing tax payment obligations. In the UK, Value Added Tax (VAT) and Pay As You Earn (PAYE) taxes, for instance, must be paid on time. The VAT element in particular, must be paid to the HM Revenue & Customs (HMRC) when it is due – failure to do so can lead to fines and escalating cash flow issues.
Fortunately, HMRC offers a programme called “Bad Debt Relief” to help alleviate losses suffered by businesses when customers fail to pay for VAT taxable goods and services. The programme allows business owners to reclaim the portion of the VAT element that was already paid to HMRC but not yet collected from the customer.
Tips on How to Avoid Bad Debt
SMEs can lower the incidents of debt recovery activities by setting clear payment terms with customers before the sale is made. The probability of bad debt is minimized when the terms are worded to enable receiving payments as quickly as possible.
It is recommended that SMEs run a thorough credit check and obtain references on all new customers. An upfront deposit should be collected in those cases where a potential new customer has questionable credit. A monthly scheduled payment plan setup may improve cash flow as well.
Developing a collection policy that includes a provision to offer a cash discount is a good idea too. It may motivate good paying customers to take care of invoices early and encourage late paying customers to settle late invoices faster.
SMEs will continually face challenges of bad debt recovery. Even so, each one can incorporate business policies and implement practices that lower the risks of acquiring bad debt. The results may lead to a calmer physiological and psychological state of mind for owners, staff and not that surprisingly, customers too.
