Most businesses offer trade credit to their customers – chances are that yours is among them. If it is, then there’s a real risk that one of your customers could become insolvent. So what does this really mean?
In simple terms, insolvency means that a business can no longer pay its creditors. From your standpoint, it could mean that your invoices will go permanently and completely unpaid, which could in turn push your firm towards insolvency.
It’s no exaggeration to say that dealing with insolvent customers is one of the most significant challenges that can face a business. Thankfully there are steps you can take to mitigate the situation – or guard against it happening at all.
Insolvency: the warning signs
When a customer is about to become insolvent, there are often clear warning signs. Companies facing financial difficulties usually pay their bills as close as possible to the due date or even in arrears. This is often an indication that a business is in trouble and living a hand-to-mouth existence, struggling on from month to month in the face of adversity. As a result, you should be cautious if you are constantly having to chase a customer for money.
It also makes sense to keep abreast of developments in your customers’ industries. If a business is failing, there are likely to be news stories or speculation in the specialist press; an absence of stories about new business wins or hirings can also be a red flag.
More broadly, make sure you research each customer in depth before extending credit. A credit score is unlikely to be a perfect indicator of financial stability, but it’s certainly a guide that you can use to manage risk. Even with these measures in place, the unexpected can happen and a customer can begin to miss payments.
The first missed payment and what to do about it
Missed payments are a regular feature of business life, and it is important not to overreact. A missed payment can often indicate an oversight by a customer’s accounts department – but it can sometimes suggest much more serious problems.
As a first step, you should call the customer, discuss the late payment and ask whether they can pay immediately. If not, under the Late Payment of Commercial Debts (Interest) Act 1998, you can charge late payers interest on their outstanding debt – a strong incentive for solvent customers to pay on time.
Should the customer refuse to pay and ignore subsequent attempts to enforce the debt, you can issue a statutory demand giving the customer 21 days to pay or face legal action. If payment has not been made within three weeks, you may then be able to wind up the company, assuming the debt is £750 or more. However, this is a very serious step, which can result in the liquidation of your customer’s business without guaranteeing you any payment.
What happens when a customer is clearly insolvent?
An insolvent customer is very different from one that is difficult or slow-paying. As soon as a customer becomes insolvent, your business is at serious risk of not being paid. In the event of liquidation, you may receive a small amount of the debt but are unlikely to receive the vast bulk of what you were owed.
In these circumstances, your options are fairly limited. You should let the liquidator know that your business is a creditor, and if a Company Voluntary Arrangement is proposed you can agree to the arrangement and to receipt of a specified proportion of the debt. Finally, if your contract includes a retention of title clause, you can talk to a solicitor about recovering the goods you sold to the insolvent customer.
Mitigating the damage customers can cause your business
If a few key customers generate most of your turnover, the insolvency of any of them could threaten your business. You should therefore take rapid action to diversify and open up new revenue streams, and make certain that your customers are solvent, dependable and worthy of trade credit.
Meanwhile, trade credit insurance can protect your outstanding debts when customers become insolvent. This type of insurance ensures that you are paid in any event and can significantly reduce credit-related losses.
However, your best defence is to maintain a diversified portfolio of customers and be cautious about extending credit. To discover how Cashsolv can help, please visit our cashflow solutions page..