How to Deal with Bad Business Debts

August 30, 2007

Companies thrive by building trusted business relationships with their customers. Sometimes, however, small business owners find that customers fall behind in payments for goods or services they’ve already received. There are a number of ways to deal with this problem, according to the Connecticut Society of CPAs, depending on each situation.

Review the age of your receivables.

It is easy to miss the trends in your customers’ payment histories unless you review the age of your accounts receivable at least once a month. Accounting software programs can provide this information in an aging report if the receivable was entered when the purchase was made or the service provided to the customer. Monitoring the age of your receivables will help in avoiding the number of customers who eventually become an uncollectible debt.

Speak up.

In some cases, the customer may be ready and able to pay but your invoice has simply slipped to the bottom of the stack. To maintain a healthy cash flow, it’s a good idea to send out monthly statements detailing the status of customers’ accounts to update them on what’s owed. If an account remains outstanding, then it’s time to contact client personnel and let them know you expect payment.

Consider legal action.

If informal reminders don’t work, you may need to take stronger action. First, send the client a demand letter that documents the fact that your company has delivered goods or services and billed for them and that the client is now in breach of contract. The letter should say when payment is required before further action is taken and what your next step will be - most likely to begin legal proceedings against the client.

Depending on the sum involved, it may be possible to pursue your case in a small claims court, which handles suits involving lower dollar amounts. You can represent yourself, which means you save attorney fees, and the process is generally fairly speedy. The dollar amount limits vary, so check with your local court to see if your case qualifies.

If you are owed a substantial amount, you may have to sue the customer in civil court. This will likely be an expensive undertaking, but the size of the debt may justify it. You will have to document the agreement between you and the customer and that you held up your end by delivering the promised goods or services.

One option for avoiding a court case is mediation. The two sides present their cases to a mediator, who helps them reach an agreement. If the outstanding debt is the result of a dispute with a customer - over the original agreement, say, or over the quality of the goods or services delivered - mediation may be a good step to consider.

Another Option: Collection Agencies

If chasing small payments is becoming time consuming, you may want to hire a debt collection agency. These agencies take on responsibility for pursuing customers with overdue accounts, even bringing legal action against them if necessary. They usually take a percentage of the amounts they collect as payment for their services. Before hiring an agency, be sure to check their references to learn about their reputation, their experience in your industry, their collection methods and their success rate.

Consult a CPA.

If you cannot collect the money you are owed, you may be able to deduct the amount on your income tax return. Internal Revenue Service Publications 535, Business Expense, and 550, Investment Income and Expenses, explain the details. You may also want to report your experience to your local chamber of commerce, the state credit bureau, or the Better Business Bureau so that other businesses and lenders will know about your problems with this customer.

Collecting overdue debts can be a frustrating experience for small business owners. Your CPA can advise you on how to work with clients who are in arrears and on how to better manage outstanding debts.

Questions? Contact Mark Zampino at 860-258-4800, ext. 212 or markz@cscpa.org.