With nearly half of SMEs having more than $20,000 in overdue invoices tying up their cash flow, business owners must be more proactive in mitigating the risk of late payments and bad debts, writes Damian Arena and Kirk Cheesman.

It’s not surprising cash flow and bad debt keep many business owners awake at night. After all, unpaid debts lead to poor cash flow, and in the worst cases, poor cash flow leads to insolvency.

While almost half of all small businesses have more than $20,000 owing to them in late payments, according to the ASBFEO Late Payment and Practices Inquiry, a recent report by National Credit Insurance shows businesses are staring down the barrel of a sudden ‘spike’ in trade credit risk.

And we don’t have to look further than two of the biggest market sectors to see how the perfect storm gathers.

Increasing competition for jobs within the building and construction industry has resulted in declining profit margins. This, combined with delays caused by weather events and industrial disputes, means construction companies often lack the funds to pay suppliers and subcontractors.

Similarly, many retailers and service providers are failing to adapt to digital disruption and overseas competition. They too are finding themselves in financial strife because of declining revenues.

The effects spread far and wide: often, debtors struggle to pay their creditors simply because they’re not getting paid by their own debtors.

Failing to pursue unpaid debt is costly. The ensuing cash flow issues will damage a business’ reputation with creditors, while their debtors will continue push the boundaries further. And writing off debt altogether can have devastating effects, such as demoralised staff and the inability to pay fair bonuses and hire new talent.

So, it’s time to kick off this new financial year with a more proactive and robust debtor management process. Here are some tips to help your business avoid falling foul of bad debt:

Get to know who you’re dealing with

Make yourself aware of any adverse information that might affect your decision to provide credit.

With the help of credit reporting agencies, it is possible to identify companies with overdue debts, court actions, and find out whether their directors have historically been involved in insolvent companies.

Set some terms and conditions upfront

By agreeing with the terms of credit before entering a new customer relationship, both parties will avoid surprises.

Stipulations around payment times and processes will prompt debtors to organise their affairs in accordance with your expectations, and provide recourse for creditors to act immediately when terms haven’t been met.

Maintain continuous communication

Businesses often struggle to pay invoices on time because of inefficient internal processes.

Regular reminders throughout the specified payment period could result in a significant reduction in payment times.

It also prompts debtors to raise any issues which they might otherwise use to delay payment.

Where there are continued delays, credit managers should communicate in person to understand the challenges and help facilitate recovery, either independently or through third-party debt recovery.

Make it easy to pay

Make it easier for debtors to organise their activities by giving them everything they need upfront.

This could include notices of balance owing immediately before the due date, with links to easy and instant payment options.

Don’t leave it too long to collect payment

There are hidden costs associated with holding unpaid debts – chasing debts can be a long and arduous effort. But the longer debt is left, the harder it becomes to collect.

If a debtor is struggling financially, you’ll quickly find yourself at the back of the queue if you don’t speak up early.

And don’t forget about your upfront payment terms; these can help identify the earliest opportunity to initiate debt recovery proceedings.

Consider credit insurance

If large sums of money are owed by individual customers at any given time, the effects of non-payment could be devastating to a business.

In this instance, it may be wise to take out credit insurance to reduce your own risk of insolvency.

A proactive approach is key to effective debtor management. Businesses that take proactive steps reduce the risk of falling foul to bad debts and increase their chances of prompt recovery when issues arise.

It also cements your reputation as a diligent, organised and professional organisation – one that employees and customers alike will want to be involved with.

Damian Arena is the managing director of debtor management software provider IODM and Kirk Cheesman is the managing director of National Credit Insurance (NCI).