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Updated: 8th January 2021

How can your company guard against bad debts and potential insolvency

Bad debts can be a particular problem for SMEs, quickly leading to financial distress if the situation is not quickly addressed. Chronic cash flow difficulties often begin when a customer pays late, with some businesses facing extreme financial issues when their ‘blue chip’ customer simply does not pay at all.

In other instances a customer may have entered insolvency themselves, which leads not only to non-payment of an invoice, but to a lack of future work for sub-contractors and suppliers.

If you are experiencing worrying levels of bad debt in similar circumstances to these, you can protect yourself from potential insolvency by taking one or more of the following measures. 

Provision for bad and doubtful debts

Estimating the level of bad debt you might experience goes some way to mitigating the risk – if you allocate a percentage amount based on the previous year’s bad debt figure, it will offset the actual amount of bad debt losses at the end of your financial year. 

Although it may not cover the unexpected loss of a main contractor/customer, making such a provision reduces the overall detrimental impact on your business. By taking out bad debt protection insurance, however, you can further strengthen your resistance to potential insolvency.

Bad Debt Protection insurance

It can be difficult to judge your own level of risk from bad debt, particularly if yours is a new business. Insurers now offer a range of different types of cover, depending on your needs. These include:   

Whole Turnover
Your entire sales ledger is covered for a specified period, which is usually 12 months. The main advantage of this type of cover is the extensive protection it provides against the insolvency or non-payment of more than one customer. 
This flexibility means it can be tailored to your business. If you have just one or two key customers whose insolvency would have a catastrophic effect on your own company, you gain peace of mind and can focus on other business areas. 

Specific Accounts
The losses that occur when a large customer enters insolvency can be devastating. They cause severe financial distress for your own organisation if you don’t prepare - specific accounts insurance allows you to do this by covering selected buyers.  
An unlimited number of invoices may be covered with this type of policy, so mitigating the risks associated with a large customer becoming insolvent. If they constitute a high percentage of your overall turnover, you gain some protection against the ‘domino effect.’ 

Late payment cover
With these policies, the provider generally takes over the collection of a debt after a certain length of time of non-payment.
Taking out any type of bad debt protection insurance can help your business obtain finance in the future. It increases your creditworthiness in the eyes of lenders, and could reduce the overall cost of lending. 

Effective credit management is the starting point when protecting your business against bad debt. Credit-checking each customer, both at the start of your business relationship and at regular intervals as trade continues, keeps you aware of any issues your customers are facing.
Credit reference agencies will provide you with details of County Court Judgements made against a company, financial results, and how other suppliers have fared whilst trading with the customer. 
Bank and trade references can also be useful in gaining an overall picture of their credit-worthiness, but make sure that you decide which trade references to use, rather than your customer putting forward their favoured sources. 

Setting credit limits
Setting and regularly reviewing credit limits helps to control your exposure to the risk of bad debt. You may wish to set a lower credit limit for new customers, until you have an idea of how they will pay.
SMEs often don’t have the cash to cover litigation, so pre-emptive action is often necessary in order to to protect themselves.
For further advice on guarding against potential insolvency as a result of bad debt, call our experts at Real Business Rescue. We can offer professional guidance on credit management, the best type of bad debt protection insurance, and how to deal with a compromised cash flow.
If one of your customers has already caused financial difficulty for your business, we may be able to arrange alternative funding to steer you away from insolvency. Our extensive office network comprises 100 offices across the UK with a partner-led service offering immediate director advice and support.

Keith Tully


0800 644 6080
Director Support - Business suffering from Cash-Flow Problems?
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