Debtor control: bad debt

It is important to try and minimise the occurrence of bad debts, as once they are bad debts they cannot be managed, that is recovered.

Here are a few steps you can take to try and minimise the occurrence of bad debts.

References

You should definitely consider asking for references where significant amounts are involved. What level is "significant" should be decided in advance through your risk assessment process. Ideally, you need two trade references and a banker's reference. Having received the trade references, it is advisable to ring the organisations involved just to check that they are exist.

Credit checks

You could consider, especially if the amount of credit may be high, to run a credit check on the customer. This can be done through a variety of organisations or by doing an online search on "credit check" through any search engine.

If you fail to receive adequate references or the credit check proves unsatisfactory, you could invoice the client pro forma; this is really cash before delivery. Here, an organisation would send an invoice prior to doing anything: the goods are only sent or the services performed after the customers cheque has cleared through the bank. You could for instance consider only offering of receiving cheques for instance but this may put off some potential purchases of your services or products.

Credit limits

You could consider setting credit limits. The limit will depend on your judgement based on a number of factors such as the length of time the debtor organisation has been established and its size. It should not, as a matter of good internal financial control, be exclusively decided by the fund-raising or sales staff.

Credit limits may also help you avoid a variety of the "long-firm fraud". Although this is not common in the voluntary sector, it is certainly important to be aware of it. This is where a new client builds up a reasonable track record with you and they pay on time on each occasion. After a while, a really big order is received and after you have fulfilled it, this is not honoured.

Payment patterns

Finally, you can try to spot potential bad debts by their payment patterns. An example here would be a customer who occasionally sends a round-sum cheque, for example £1000 or £10,000. This can sometimes be an indication that the customer has money problems: an organisation with cash flow difficulties sometimes looks at how much it owes and attempts to work out the minimum it can afford to repay whilst keeping its suppliers reasonably happy. This often results in round-sum cheques.

It is very important that as you look at ways of minimising bad debts you also have debtor controls in place. Effective debtor controls will enable you to identify early on and take action to try and minimise the risk of your debtors turning into bad debts.

If you are in the unfortunate position of having a bad debt then there are a number of ways you can try and recoup this bad debt. These include:

taking legal action
writing off the bad debt
collecting your debts through factoring.

Writing off bad debts

Authority to write of bad debts should not be within the authority of either the sales or fundraising staff, or the sales ledger clerks. The trustees should decide who has the authority to do this and up to what amounts.

There is a difference between writing off an outstanding error of say £18, when a debtor paid £2,568 when he should have paid £2,586; and writing off the whole £2,586. A fairly junior official can agree the former; the latter might need to be cleared by the trustees. It depends on the size of the organisation. What is important is that procedures are agreed and kept to.

Collecting debts through factoring

When you factor your debts you are in effect selling them to a third-party who makes their profit by charging you a commission, which normally varies between 2% and 5% of the total amount involved.

The advantage of factoring is that you get most (usually about 80%) of the amount of money owed immediately, which improves cash flow and cuts down on overdraft interest.

Unfortunately, factoring companies prefer small numbers of debts from large organisations with a high average value. This does not always fit with most charities' debtor patterns, as these tend to be of small value and from a number of individuals or organisations. It is also a rather expensive way of collecting your money quickly.

For further information visit the Factors and Discounters Association (FDA) website.