The importance of a robust debt collection strategy for limited companies

Written by Begbies Traynor

Unpaid invoices have the potential to disrupt financial stability for limited companies and create a challenging operational environment. The cash shortages that commonly result from overdue or unpaid invoices can be minimised by adopting robust debt collection processes, however.

If debt recovery isn’t prioritised and assigned the required urgency, it hampers growth and poses a serious risk to a business’s success. So how can limited companies mitigate this risk and what are the ultimate consequences of failing to act?

What constitutes a robust debt collection strategy?

These are three key elements of a strong debt collection policy:

• Good credit management

Good credit management is fundamental to effective debt recovery. A credit management policy should include checking the creditworthiness of new customers using credit risk reports so directors can be realistic about the levels of credit that are initially offered. Existing customers’ credit ratings can also be checked intermittently to determine whether they’ve experienced any financial decline. Similarly, their credit levels can be reviewed using up-to-date information. These pre-emptive actions safeguard the company from excessive bad debt and support its debt collection strategy.

• Clear communication

Coherent communication is important when setting out a company’s terms of trade. Payment terms, including the company’s legal right to charge interest on outstanding debts, can be reiterated on documentation throughout the sales cycle. It would clearly convey the company’s requirements if terms were included on quotations, for example, sales orders and contracts, as well as on sales invoices. Following up with a system of automatic payment reminders consolidates this strong debt recovery strategy.

• Offering a range of payment options

Offering easy and convenient methods of payment to customers lays the foundations for invoices to be paid quickly. This might involve including a link to pay on an emailed sales invoice, for example, or offering direct bank transfers. A policy of negotiating with debtors who are struggling to pay their invoices can also provide a favourable outcome. Even though the company will receive less than expected initially, the subsequent regular instalments provide valuable cash inflows and can retain customers who may simply be experiencing temporary financial issues.

Why does a company need to build a reliable debt collection strategy?

If invoices remain unpaid for any length of time, the resulting drop in cash availability can make it difficult for a company to pay its own debts. Cash ‘oils the wheels’ of business and financial instability could ultimately result in cash flow insolvency.

Additional knock-on effects of failing to collect debts effectively, and the subsequent impact on cash flow, include a lowered credit rating if the company defaults on its liabilities. This can lead to further difficulties - in obtaining borrowing, for instance, and a potential loss of reputation.