How to Limit Bad Debt Losses

By Michael C. Dennis, MBA, CPC, CCP, CBF

A bad debt represents an accounts receivable balance that has reached the point of being uncollectable. For most credit managers, releasing orders to accounts that may be considered marginal credit risks is often a necessity, leading to the inevitability of bad debt losses. Occasionally, a single bankruptcy within a supply chain can trigger a domino effect, causing financial distress among multiple suppliers.

When you suspect that one of your customers is encountering financial difficulties, it's crucial not to panic but instead focus on ways to minimize or mitigate potential losses. Here are several strategies to consider for reducing credit risk:

1. Offer Incentives: ?Extend an offer to the customer in question for a substantial discount in exchange for immediate payment. It's essential to be aware that if the customer declares bankruptcy within 90 days, the payment received might be categorized as a preferential transfer, potentially requiring its return.

2. Cash on Delivery (COD): Implement a cash-on-delivery requirement for all future sales to your high-risk customers. This approach ensures that payment is secured upfront, minimizing the risk of non-payment.

3. Stay Informed: Actively participate in credit group meetings to stay updated on developments related to the customer in question. Collaborating with peers in this manner can provide valuable insights into the customer's financial stability.

4. Request Security or Collateral: ?Consider requesting a security interest from the customer. If the customer agrees to this arrangement, allocate the time and resources to perfect your security interest.

In many cases, companies that extend credit tend to respond slowly to early indicators of a customer's financial distress. This may be because credit team members may hesitate to share their concerns with superiors, fearing repercussions. To address this issue, it is imperative to establish a culture where reporting and discussing concerns about a customer come with no risk to the individual making the report.

In conclusion, proactive measures can significantly reduce the impact of bad debt losses. By implementing strategies like offering incentives, requiring COD, staying informed, and requesting security interests, credit professionals can enhance their ability to manage credit risk effectively. Encouraging an open and risk-free reporting culture within the organization further strengthens the credit management process.

Excerpted from my recent book, "Customer Profit Hacking"

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