Bad Debt Rising: How to Avoid These 5 Mistakes

For the past several years, America has been living in a New World Wealth Machine. This was a term coined by Professor John C Edmunds of Babson College in his book Foreign Policy. For him, the New World Wealth Machine meant wealth was created by the financial markets and was used to drive the economy forward.

He said “Many societies…have learned to use wealth directly. This new approach requires that a state finds ways to increase the market value of its stock of productive assets…an economic policy that aims to achieve growth by wealth creation therefore, does not attempt to increase the production of goods and services, except as a secondary objective.”

Historically, the most effective way to inflate the value of productive and non-productive assets was to lower inflation rates. But lately, the wheels of the machine have slowed down. Worse still, it’s breaking down because of high inflation rates, ongoing supply chain disruption, a labor crisis and political turmoil.

A major consequence is that more companies are taking on bad debt and hurtling towards cash losses and bankruptcy in some cases. According to CNBC, corporate debt soared by 80% in 2023, while the Fed is carrying a $1.3 trillion debt load.  Looking ahead over the next decade, US debt is expected to top $54 trillion. 

The good news is there is plenty you can do to avoid bad debt and come up with debt prevention strategies. 

1. Not having a proper credit control policy

One of the biggest mistakes we see is that businesses don’t have any kind of defined credit control policy in place. They might have an idea of what it looks like, but it hasn’t ever gotten past the theoretical stage. There’s no connection with important financial data points or any consideration of things like: 

• The number of customers that you can put on credit or who the most reliable are for payments.

• The exact standard of on-time payments for your industry. What is the average DBT score in your sector?

• The amount of time that’s being taken to collect payments or chase late payments.

• The legal guidelines of your state and industry. What are the rules of debt collection that you must comply with?

• The method of recording all the information in your credit policy. Is it all done manually or is there specific technology that’s being used?

Now, if you’re a small company then you may not have the resources to create a credit policy. But as a bare minimum, you’ll need to write it down and think about how to move it forward one step at a time. (We’ll go into more detail about this later).

2. Lack of follow-through 

A lack of consistency on multiple fronts is another reason why bad debt builds up. The most obvious mistake here is taking too long to follow through on late payments or just assuming that a customer will have seen an invoice and be ready to pay as soon as you ask. 

Then there’s the potential hesitation of not wanting to ruffle any feathers by escalating an outstanding payment to a court decision. At the end of the day, you have a business to run or are part of a business that needs constant cash flow. If you’ve taken steps to try and resolve late payments amicably and the issue still stands, you’re within your right to seek legal action. 

A secondary issue, (but one we see happen over and over), is businesses only running a credit check on a customer once. They sign a contract and either expect everything to be smooth sailing or make another assumption that any problem is manageable without needing to be hands-on. That’s a dangerous attitude to have. 

Remember that markets are always shifting and the rug can be pulled out from under you at any moment. And if you have no debt management strategy to cushion your fall, then it’s going to hurt your bottom line.

3. Misaligned sales and finance teams

A disconnect between sales and finance is a driver for late payments and chaotic credit policies. On one hand, sales need to understand the factors of the credit policy and the outcomes that will lead to a rejected deal. 

On the other hand, finance expects to see that the sales team is using the credit policy to inform their decisions and to stop late payments from happening.

Here are the signs of sales and finance not singing from the same hymn sheet:

• Sales are closing deals without bothering to check credit report data and then those deals are getting rejected by finance.

• Finance execs aren’t making it easy for sales execs to understand the financial information needed to vet customers.

• A lack of coordination in meetings or a lack of interest in sales wanting to join conversations with finance and vice versa.

4.  Relying on one-size-fits-all payment terms 

Net 30 is a common payment terms number. It’s an expectation that a customer will pay an invoice for outstanding services or products within 30 days of receiving the invoice. Many companies may choose this approach because it seems logical. Generally, staff are paid on a 30-day rolling basis and it can feel like a simple equation to work to, right?

This is a generalized example that doesn’t take into account industry, lead times or customer lifecycles. Relying on only one kind of payment term is a sure way to shoot yourself in the foot when getting paid.

Let’s return to our Net 30 example. You may find that a customer’s credit report reveals a DBT of 12 days or more and millions of dollars in past due payments. Net 30 isn’t going to work here and you’ll need to rethink your terms if you want to avoid bad debt. Instead, you may ask for full payment in advance to make sure you’re covered in future. 

5.  Slow, manual processes

The final debt management sin on our list is when a business remains stuck in manual processes. The kind that involves typing by hand into spreadsheets and sending invoices as PDF attachments. There are a couple of disadvantages here.

Firstly, you increase the chances of entering data wrong. Imagine if you have a spreadsheet with thousands of data points and you make even a few errors. You’re going to spend a lot of time looking through pages of information to correct those mistakes.

Secondly, wrong information on paper PDFs takes more time to fix. Plus, sending several emails back and forth about those mistakes is going to get hard to keep track of in a mountain of emails. You’re probably receiving emails about a dozen other things that need your attention.

The bottom line for your bottom line is that manual isn’t the way to go if you’re trying to maintain effective debt control.

Get your credit policy in order 

To go back to mistake number one, we’d suggest you think about answering the points we’ve listed. This will give you benchmarks to start measuring your existing policy against and finding out what you need to address and then you can (re)write as needed: 

Here’s our suggestions for writing your policy:  

• Purpose statement: A summary to go at the top of the policy that states this is your credit policy. Can be two or three sentences.

• Statement of scope: The next section should feature the types of clients and sales that your credit policy focuses on. 

• Credit and payment terms: Arguably the most important part of your document. State your credit limits, how you determine interest rates, late fee penalties and how long clients have to repay invoices. 

• Credit application and review: This section should detail how your business processes credit applications and reviews the credit history of creditors that’re established. List anything that would create lower credit lines.

• Sales terms: The sales department may want flexibility to have credit terms that work for certain customers. This section should have specific wording that allows them to modify terms to increase sales while continuing to protect company cash flow.

• Statement of credit team roles: Finish the policy with a statement about who on your team is responsible for credit control tasks. This makes it clear to you and debtors on which staff can be contacted. This shouldn’t be overlooked. If this section isn’t clear then an unauthorized person may accidentally extend credit when it’s not possible and damage cash flow and customer relationships. 

Have an iron-clad collection strategy

According to the Commercial Collection Agencies of America, at 30 days overdue, collection rates drop 89%. At 90 days, the chances of collecting drops 70%. This is a huge symptom of mistake number 2 and here’s how you can navigate it: 

• Offer easy payment terms through a self-service portal.

• Adjust payment terms as necessary to maximise the chances of you getting paid on time.

• Charge late fees and increase the percentage based on the number of days that payment is overdue. For example, after seven days late it could increase from 5% to 10%.

• Hire a debt collection specialist to remove the friction of chasing customers. Do thorough research into an agency and make sure they have a good track record and are above board in how they collect.

Create synergy between teams   

Our CEO of the Americas and Asia, Matthew Debbage, has some great tips for solving mistake number 3 and getting sales and finance on the same page:

“The two teams need to work together to mend their fractured relationship. It’s not going to happen overnight. But it will happen eventually if both teams come to the table with an open mind, a willingness to listen to each other and a curiosity to understand the motivations and goals of each team.

From there, the finance team needs to take ownership of not just creating a credit policy but also documenting it, sharing it and hosting interactive sessions with the sales team to help them understand what’s included in the credit policy – the factors they consider, the reasons those factors are deemed high risk and why those factors could hurt their earning potential and ability to close deals. It can seem like just sending a large PDF of the credit policy to the sales leader should qualify as sharing the policy. But it’s not. More often than not, that PDF will just sit in the inbox unread – or even deleted – by salespeople. 

It’s important for the finance team to do these types of interactive sessions to show them why the credit policy exists and include real-world scenarios they’re likely to encounter with prospects. Remember, salespeople are motivated by money and are measured by their ability to close deals – so, finance teams should talk in the language salespeople will understand.    

This doesn’t mean the sales team has no responsibility in this matter. Once they’ve been informed of and trained on the credit policy, they need to make sure they’re looking at the necessary financial data early on so they aren’t wasting hundreds of hours chasing a deal that will end up getting rejected by the finance team in the 11th hour. And if they don’t have this type of data available, then they need to push their sales leader or technology leader to bring on the right tools (or integrate with a platform that has credit risk data).”