7-Step Action Plan to Avoid Writing Off Bad Debt

You have a great sales team who consistently acts on and converts leads into deals. They’re passionate about their jobs and deeply understand the challenges prospects need help solving.

Many sales deals have been closed lately. That all sounds great at first (because that means revenue for the business), but then you realize these new customers aren’t paying their invoices on time (with some going into delinquency past 90 days) or they have dozens of legal filings against them (resulting in exorbitant fees). But it’s too late to salvage anything because the contracts have already been signed. So, now you’re stuck with these late paying customers.

In this scenario, it might seem like all you can do is write it off as bad debt so you can move on and focus on those customers who can and will pay on time. Sadly, this is a situation we see happen often with companies because they haven’t done the due diligence to avoid accounts receivable write-offs. 

According to Gartner Finance Research, bad debt has been increasing over the past couple of years – increasing 25.8% year-over-year in 2020. So, it’s important to understand what causes bad debt and put an action plan in place to avoid having to write them off.

Lack of alignment and collaboration between sales and credit control teams is a common issue. The sales team is often heavily focused on chasing deals and hitting monthly targets to be bothered with checking the financial health and payment behaviors of their prospects. And more often than not, their existing CRM platform doesn’t show that information or doesn’t integrate with a credit risk intelligence platform to show that information. So, they don’t even realize that type of information is important and could drastically improve their deal closing rates and increase their sales commissions.

Meanwhile, the credit control team will likely have developed a comprehensive credit policy and is using it when deciding to approve or reject sales deals. But the reality is that most sales teams have no clue about their company’s credit policy, according to our ‘Sales vs. Credit Control Battle’ research study. In fact, 42% of the US sales managers we surveyed admitted they had little to no understanding of their company’s credit policy. That might explain why 47% of the respondents said their deals are rejected by the finance department, with up to 10 deals rejected per month. What these stats indicate is that, although credit policies may exist, they aren’t being communicated and shared with the sales team in a way that they can understand and will be more inclined to review up front before spending hundreds of hours pursuing a risky prospect. 

Adding to the tension between the sales and finance/credit control teams is the incomplete data typically pushed into CRM systems. While these platforms are useful for contact and company information on prospects, most CRM platforms don’t have any data about your customers’ financial health, payment history, credit risk levels, legal filings and compliance violations.

Without that information, your sales team isn’t getting a complete picture of their customers and are more likely to have deals rejected by your finance team in the 11^th hour. This was evidenced by our recent study, which found that 54% of sales managers waste up to 20 hours a week pursuing leads that don’t meet the company’s credit policy. On top of that, our study revealed that 47% of sales managers have up to 10 deals rejected by the finance team for this very reason.

So, now that we know what’s causing bad debt to occur, let’s talk about how you can avoid having to write off bad debt.

The first step is to reassess your current credit policy and look into factors such as: 

• The number of customers you can put on credit: Which customers are your most reliable (paying regularly on time)? Which customers have several past due invoices and rarely pay on time? 

• Your team’s level of comfort with debt collection: How confident are you with chasing late payments? What’s your overall debt collection strategy? How often are you following up with customers to chase late payments? Are you waiting too long before sending late payers to a collection agency?

• The standard of on-time payments among peers in your industry: Look at third-party data to benchmark your average DBT (days beyond terms) against peers in the same industry. 

• The amount of time to wait for repayment: How long can you last without getting paid? Can you manage for some time if you're not receiving payments within terms?

• The legal considerations of your state and industry: Speak to a credit control lawyer who’s familiar with federal guidelines and the workings of your industry. 

• The method of documentation: How are you going to record all the information in your credit policy and what kind of terminology will you use?

Now, what if your business is on the smaller side and you haven’t had the resources, skillsets and bandwidth to create a credit policy? For you, the first step is to write your credit policy.

While you certainly need to think about the above factors I already mentioned, you also need to structure it with the right information and make it easy to understand and use. We’ve outlined some key sections you should include in your written credit policy:

• Purpose of the credit policy
• Credit and payment terms
• Credit application and review
• Sales terms
• Overview of credit team roles
• Debt collection strategy (including processes, systems, tools, collection agency)

The amount of times we’ve spoken to companies who say they only run a credit check on potential customers once (before signing a contract) is too many to count. It’s a persistent and dangerous problem. Yes, I said dangerous. Why? Remember, things are constantly changing – if the pandemic hasn’t taught us that, I don’t know what will. The economy can take a turn for the worse, as we’re already seeing right now with rising inflation rates, a cost-of-living and energy crisis, supply chain disruptions and labor shortages.

All these factors affect business growth and usually not in good way. So, you’ll often see businesses go up and down with their financial health and payment behaviors. If sales are strong and consistent, cash flow could be very healthy. But when a downturn hits, customers cut back on spending and that can cause a serious decline in revenue for your business, which could have a domino effect and force you to pay your suppliers late. It’s a cyclical effect.

That’s why we can’t emphasize enough how important it is to run credit checks on your customers – both potential and existing customers – throughout the entire customer lifecycle. Their financial health and circumstances could have been much stronger when you first signed a contract with them, but then could have declined drastically due to both internal and external factors. So, don’t just run the credit check once. Run it regularly and look at more than just their credit scores and credit limits. Look at how many legal filings and UCC filings they have – is that costing them millions of dollars? Look at how they compare to other companies in their industry – are they well below the average for DBT (days beyond terms)? How many of their invoices are past due and what does that amount come to?

If you’ve been seeing all the recent news about American retailers going bankrupt, then you’ll understand why I’m making this recommendation. Just look at what’s happened to Serta Simmons Bedding.

To get a better understanding of this, I had a chat with Matthew Debbage, our CEO of the Americas and Asia. Here’s what he had to say.

“When you think about how the recession has impacted American consumer spending and then you look at the types of products that Serta Simmons Bedding sells and the high price points, it’s not hard to see why they filed for bankruptcy. As consumer spending has dropped, mattresses are likely to be one of the last things people will spend their money on. They’re more likely to postpone upgrading their existing mattress and use that money to pay necessary bills for rent/mortgage, utilities, internet/phone and loans.

These factors likely put a strain on Serta Simmons Bedding’s cash flow. With less sales coming in and potentially more cash going out (repaying the $200 million loan it received in 2020 as part of a refinancing agreement to stay afloat during the pandemic), the mattress manufacturer didn’t have much choice but to file for bankruptcy. But our credit risk data shows that the company is slowly but surely rebuilding its financial health. 

While its average DBT (days beyond terms) fluctuated between 7 and 11 days over the course of 2022, it was much lower than the average DBT (between 9 and 11 days) in the furniture and home furnishings industry for most of the year. This could be seen as a positive sign by its lenders (old and new) that Serta Simmons Bedding will be able to repay its loans in a timely manner.” 

Payment terms are basically like deadlines for your customers. It tells them when their invoice payment is due and sets that deadline in relation to when an invoice has been submitted. 

Payment terms can include:

• Net 30
• Net 60
• Net 90
• Full payment in advance
• 50% payment up front / 50% payment upon completion of work

Don’t just randomly choose payment terms or use the same terms for all customers. Use credit risk data to decide what the right payment terms are for each customer. 

If you can see in a company’s business credit report that they have a DBT of 10+ days and they owe a lot of money ($ millions) in past due payments, then Net 30 payment terms could leave your business in the lurch. So, you might want to require 50% payment up front and then the remaining 50% payment upon completion of work. The key here is to not use a one-size-fits-all approach to setting payment terms.