What bad debt is and how to erase it

There’s debt, and then there’s bad debt. ‘Surely all debt is bad debt’ you might think. But apparently not. Our regular blogger and resident debt collection advisor Cash Protection Agency (CPA) say there is a difference in the kinds of debts a business may have. We grilled CPA’s expert Denise Parkinson on how bad debt is defined and what to do to erase it.

What is bad debt?

Debt is money that is owed. And debt becomes bad debt when the creditor has made all reasonable efforts to collect debt but has been unable to do so.

Is there such a thing as good debt?

Experts say there is good debt, but they disagree about what defines it. An example of good debt might be a mortgage meaning you have your own home. A car loan is another example as this enables you to get to and from work, however, you must be able to afford the repayments – don’t buy a Ferrari when realistically your budget allows for a Mini. Investing in your own business might also be considered good debt as it will help to develop it; providing you have a sensible, realistic plan to pay back the loan.

How does bad debt affect businesses?

It could cause serious cash flow problems depending on the size and structure of the business. If a business is owed significant amounts of money that they’re unable to recover it will lead to creditor pressure. They may find themselves with escalating debts that they cannot afford. For the smaller companies and sole traders it could mean closure.

How can companies eliminate bad debt?

The first step is to already have good credit control procedures in place and to have followed all the steps outlined in our last blog regarding credit control.

It helps to realise early on that the account isn’t going to be paid. I see it all too many times when a client doesn’t chase an account for fear of upsetting a long-established client and they just hope that they will pay eventually. This also happens if a client is due payment from a local authority, people assume they are government officials so will pay up but not necessarily.

Don’t take things for granted. If an account is overdue by 120 days when your terms clearly state they have 30 days to make payment. Alarm bells should start to ring at this point definitely. It is now time to start threatening interest or put their account on hold. Send a final notice and if this fails, sending their account over to a third party for collection should do the trick.

How long can businesses expect for bad debt to clear?

Every debt is different. It may be that a company will set up a payment plan with their client to clear the debt. Or, a company may have to send the account to a third party such as a debt collection agency or solicitor, in which case it will all depend on the company’s or individual’s circumstances. What I will say is don’t let it go on in the hope that they will miraculously, out of the blue make the payment.