Uncollectable Accounts Cost More Than You Think
When you finally decide to write off an uncollectible receivable, what is the total cost to you? If you think it’s just the amount of the invoice, you’d be wrong. To calculate the true impact on your business, you must add in the cost of other important factors that are often overlooked by management:
- Less Credit / Lower Sales
Accounts receivable are typically used as collateral for a bank line of credit. A bad debt, therefore, means a reduction in the bank line of credit. Insufficient financing prevents you from accepting larger orders and inhibits your ability to grow. - Loss on Obsolete or Customized Products
When your customer doesn’t pay, you have to find another buyer for your product. When you do, you are likely to incur a loss on the sale. If you produce a customized product, your loss will be even greater since there will be a limited market for the item. - Marketing Expense of Finding New Customers
A bad debt means no more sales to the delinquent account. The lost revenue must be offset by increased sales to your other customers, if this is possible. If sales to existing customers are not enough to compensate for the lost revenue, you must make a concerted marketing effort to find a replacement. Don’t forget the old adage: “It costs more to get a new customer than it does to keep one.”
Most receivables can be collected if you are diligent, persistent and produce accurate invoices. Don’t let a collectible debt become a write-off—the cost is just too high.
After the Bad Debt is Gone, What Do You Do?
Whenever you write-off a bad debt, it’s a good idea to review your credit policy and consider whether it needs to be revised. For example:
- Should you become more aggressive in your collection efforts? If you do, how will you avoid alienating your customers?
- What level of slow-paying accounts is acceptable? Some customers will always pay late. How many slow payers can you afford to carry?
- Should you tighten your credit standards? Many business owners are afraid to do this because they fear losing sales to customers that will object to the new credit terms. Don’t make this mistake. Do you really want customers who cannot meet reasonable credit terms?
Think carefully about any planned revisions. Focus on distinguishing non-payers from slow-payers, when to cancel credit privileges and protecting your lien position.
Originally published in Kaufmann’s Capital Comments.
Practical Information. Process Improvement. Profit Enhancement.
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[...] You probably don’t need me to explain exactly why bad debt should be avoided. Absolutely no one is a fan of bad debt. However, it is worth taking a moment to discuss the true costs of bad debt. [...]