Avoiding bad debts - some practical guidance

From time to time, most businesses encounter a customer who is either unwilling or unable to pay. There are however a few things you can do to minimise the risk of non-payment.

1. Have a robust client engagement process.

The success of any project or relationship is often determined by things you do (or don't do) before its commencement. 

Regardless of whether you are dealing with a new customer or an existing one, it is critical that you have a process for setting and managing expectations before the engagement commences. At the end of the day, a satisfied customer is far more likely to pay than an unsatisfied one. A customer will be satisfied if its expectations are met. Not over-selling and managing customer expectations are key ingredients of any successful sale.

For many businesses, this process will occur largely through meetings and conversations. But ultimately, the only way to ensure a shared set of expectations is by putting them in writing. Having a good, standard form contract is the best way to achieve this - whether that is in the form of a letter, a set of trading terms, a formal agreement or some other document.

Once they are signed, contracts are often not read again. This is because the very process of entering a contract is invaluable in terms of ensuring a meeting of the minds. If the parties start the engagement on the same page, they usually end on the same page as well.

Of course there will be situations where, for whatever reason, the client is unwilling or unable to honour commitments given at the beginning of the relationship. New clients are often the greatest risk area, and this is where background checks can be particularly useful. For example, you could:

• conduct internet searches for the company, its directors and other key personnel;
• ask the client about their other service providers, to understand whether the client is used to dealing with companies like yours;
• ask your peers and colleagues whether they have had any experience with the company; and
• conduct formal checks, such as company searches through ASIC or obtain third party credit reports.

2. Consider security and payment terms.

In some cases, you may consider that the nature of the transaction (or the nature of the client) may create a greater exposure than you are willing to accept. In these situations, obtaining security and/or varying your payment terms can be an effective way to mitigate the risk.

Security can take a number of forms. The most common types of security are:

• deposits and pre-payments;
• payment to an independent escrow agent;
• bank guarantee, insurance bond or other similar undertaking from a financial institution;
• mortgage or other interest in property, sometimes including the thing being sold; and
• personal guarantee.

Pre-payments and bank guarantees are almost always the safest course. 

Keep in mind that a personal guarantee is only worth as much as the person signing it. Also, where you are seeking security by way of an interest in property, strict rules can apply. (For example, where you are dealing with personal property, including goods that you are selling, non-compliance with the Personal Properties Securities Act can render your security worthless.) 

Independently of security, you may be able to reduce the risk of default by altering your payment terms. For example, rather than waiting until the end of a project to invoice, you may wish to invoice weekly or fortnightly and require payment within 7 or 14 days. Alternatively, you may wish to require payment on the occurrence of particular events. (These are often known as 'milestone payments'.) Either way, the aim of the exercise is to limit the amount of credit you are offering to your clients. 

3. Have a system for managing your debtors.

Issuing an invoice is obviously not the end of the process. However it is surprising how many organisations do not have a clear system for managing their invoices. Ideally, your system will:

• produce a regular report of unpaid invoices;
• bring any outstanding invoices to the immediate attention of the person responsible for following it up (whether that be someone in the accounts department or in the operating team);
• have a system for following up and escalating unpaid invoices (eg reminder statements, phone calls, letters).

It is also important that your employees understand the role they play in recovering payment. Their buy-in to the process is critical to its success.  The longer a debt is allowed to linger, the less likely it is to be paid (whether in full, or at all).