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small business, cash flow, bad debt

How company credit checks can help avoid bad debt

Capitalise Aug 18, 2023

One of the most critical challenges for small businesses is managing financial risks. While growth and profitability are essential goals, they can easily be derailed by bad debt. Bad debt refers to funds that a company is unlikely to recover due to the failure of another party to honour their financial obligations. To safeguard your business's financial health and make informed decisions, company credit checks will be a crucial tool in your arsenal.

 

What is bad debt?

Bad debt refers to money that is owed to a company, but is unlikely to be collected because the debtor is not able to, or unwilling to pay. Bad debt often occurs when customers receive goods or services based on credit and fail to make the required payments within the agreed-upon terms.

 

Implications of bad debt
 

Bad debt is a significant concern for businesses of all sizes and industries. When a company extends credit to another business, it exposes itself to the risk of non-payment. If you don't know the creditworthiness of the business or their financial health, there is an increased risk. For a business, bad debt and unpaid invoices can disrupt cash flow, strain resources, and ultimately impact a company's ability to operate smoothly.

The implications of bad debt also go beyond the immediate financial loss. It can strain relationships between businesses and damage reputations. In the worst-case scenarios, bad debt can even lead to insolvency or bankruptcy, making it crucial for businesses to take proactive measures, such as a credit control process to mitigate the risk.

 

How company credit checks can help to safeguard against bad debt

A company credit check involves assessing the business credit profile of potential clients, partners, or suppliers. Company credit checks provide valuable insights into their financial stability, payment behaviour, and overall credit risk. Conducting credit checks helps to make more informed decisions about extending credit, entering into financial agreements, or partnering with another business. 

 

  • Estimate the likelihood of on time payments 

Company credit checks allow you to evaluate the creditworthiness of a business before choosing to work with them. By viewing their business credit score and credit profile history, you can gauge the likelihood of receiving on time payments

 

  • Identifying red flags

Credit checks can reveal red flags such as a history of late payments, or CCJs. Adverse credit information such as a CCJ or Gazette Notice can serve as warning signs of potential financial instability or insolvency. By spotting these warning signals early, you can decide whether to proceed with the business. 

 

  • Setting appropriate credit limits

A company credit check will give you the business’ credit score and suggested credit limit, so you can set appropriate amounts. Setting realistic credit limits reduces the risk of overextending credit to companies that may struggle to repay.

 

  • Setting appropriate payment terms

Credit checks enable businesses to tailor payment terms. For example, if a potential customer has a strong credit history, you might offer more favourable payment terms. But if there are concerns about creditworthiness, you can establish stricter payment terms to reduce the risk of delayed or defaulted payments.

 

  • Building trust

When you conduct credit checks and extend credit only to financially sound entities, you reinforce a sense of trust between your company and its partners or investors. This trust can lead to more reliable business relationships and a reduced likelihood of disputes over payment.

 

  • Safeguarding cash flow

One of the most significant benefits of credit checks is their impact on cash flow. By avoiding extending credit to high-risk entities, you minimise the chances of non-payment or delayed payment, ensuring a steady inflow of funds to your business.

 

  • Reducing bad debt collection efforts

Bad debt often requires substantial effort and resources to recover. Credit checks reduce the need for extensive collection efforts by preventing you from entering into agreements with businesses that have a history of defaulting.

 

  • Preserving reputation

Avoiding bad debt through credit checks safeguards your reputation as a reliable and financially responsible business. This reputation is essential for attracting new clients, partners, and opportunities.

 

Company credit checks act as a shield against potential bad debt by providing data-driven insights that guide decision-making. By using these insights to make informed choices about extending credit, businesses can proactively protect their financial stability and maintain a healthy cash flow.

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