The biggest challenge in maintaining cash flow health is when a company operates in a credit system—either as a credit recipient or as a credit provider. Basically, the credit system does provide flexibility, but it also contains hidden risks that can lead to bad debts.
Bad debt occurs when payment obligations are not met according to the agreed time period. In the context of a company, this condition can have very serious consequences: disrupting operational cash flow, increasing collection costs, and even damaging long-term business relationships.
Therefore, it is important for every company to not only understand what bad debt is, but also anticipate it from the start—either through neat internal management or through the use of technology such as a spend management platform to help with more accurate financial monitoring and decision-making.
What is Bad Debt?
Bad debt is a condition when a party—either an individual or a company—fails to fulfill its loan or debt payment obligations according to the agreed schedule.
In a business context, bad debts often arise in B2B ( business-to-business ) transaction relationships, where one company provides payment terms to its business partners for the purchase of goods or services.
Generally, credit is considered “bad” when payments are delayed beyond a certain time, usually 90 to 180 days. In financial reports or banking systems, this status can be included in the category of “non-performing loans (NPL)” or arrears that have the potential to harm the creditor.
In practice, bad debts do not only occur in a company’s relationship with a bank or financing institution, but are also very common between a company and its suppliers or clients.
For example, a distributor gives a 30-day payment term to a retail store, but the payment has not been received after two months. This situation can be the beginning of a bad debt.
Common Causes of Bad Debt in Business
Bad debt does not just happen. In many cases, this condition is the result of a series of bad decisions, both from the lender and the borrower.
Understanding the root causes will help companies take more effective preventive actions.
The following are some common causes that often trigger bad debts in B2B transactions:
1. Poor Financial Management
Weaknesses in managing cash flow, preparing budgets, or controlling expenses often leave companies unprepared to pay their obligations on time.
Even seemingly active and busy companies can get caught in bad debts due to poor liquidity or mounting debt.
2. No Business Partner Feasibility Evaluation
Often, companies provide payment terms without evaluating the financial track record or reputation of the partner. Not conducting credit checks or risk assessments can open up high chances of future payment failures.
3. Payment Terms Too Loose
Applying payment deadlines that are too long, without any guarantees or late penalties, makes business partners feel unmotivated to pay on time. In addition, an unclear payment structure can lead to different interpretations and make it difficult to collect.
4. Uncontrollable External Factors
Macroeconomic changes such as pandemics, inflation, market crises, or new regulations can affect a business partner’s ability to pay. Even normally disciplined partners can experience challenges when faced with sudden economic pressures.
The Impact of Bad Debt on Business Operations
Bad debts are more than just a financial record-keeping issue—they can have a domino effect that threatens a company’s operational continuity and reputation. When one transaction fails to be paid on time, the consequences can ripple across everything from cash flow to business relationships.
Here are some of the main impacts of bad debt on companies:
1. Disruption of Operational Cash Flow
Bad debts directly affect a company’s liquidity. Funds that should come in from client payments are not available, making it difficult for the company to meet routine obligations such as paying employee salaries, paying taxes, or purchasing raw materials.
2. Increased Billing Costs
Collecting overdue payments is not an instant process. Companies need to allocate time and resources to conduct regular follow-ups, draft collection letters, or even seek legal assistance if necessary. All of this adds to the operational burden that should not be there.
3. Straining Business Relationships
When bad debt occurs, trust between business partners can be disrupted. The injured party may reduce the volume of cooperation, tighten future payment terms, or even terminate the relationship permanently.
4. Direct Financial Loss
In the worst case, bad debts become a loss in the books. This can worsen the company’s financial ratios and lower the assessment of investors, lenders, or other external parties.
Therefore, it is important for companies not to view bad debt as a “one-off” risk. Every potential default must be handled systematically—with early prevention, early detection, and proper handling.
How to Manage Bad Debt Risk Effectively
Managing bad debt risk requires a two-pronged approach—both when the company is in the position of receiving credit (client) and as a credit provider (vendor or supplier).
When You Are a Credit Recipient (Client)
In the position of a client, the company must ensure that all payment obligations can be completed on time.
Credit used wisely can help smooth operations, but if not monitored, it can easily turn into a long-term burden.
Here are some strategies that can be applied:
1. Maintain Cash Flow to be Able to Pay on Time
The key to keeping credit from becoming a problem is maintaining liquidity. Companies must be able to map when funds come in and out, and prioritize strategic payments.
2. Submit Restructuring If Necessary
If there are any payment problems, do not wait until the arrears get worse. Submit a restructuring to the credit institution. There are three common forms of restructuring:
- Rescheduling: rescheduling installments
- Restructuring: adjusting loan terms (interest, term, collateral)
- Reconditioning: interest relief, additional facilities, or consolidation of arrears into a new loan.
This step can save reputation and maintain operational continuity.
3. Maintain Payment Reputation
Consistency in paying on time will strengthen the trust of business partners and financial institutions. This good reputation is also an important capital if the company needs additional credit or renegotiation of payment terms in the future.
When You Are a Credit Provider (Vendor or Supplier)
When a company becomes a vendor or supplier that provides payment terms to clients, the risk of bad debt also remains. Therefore, it is important to set up a mitigation system from the start:
1. Conduct an Initial Credit Evaluation
Before providing a term facility, conduct a credit check on the prospective client. Review financial statements, payment reputation, and previous cooperation history. This step prevents the risk of default from financially unhealthy partners.
2. Set Realistic Credit Limits and Terms
Don’t give too big a credit limit or too loose a term—especially if you don’t have a long track record of working together. Start with a small volume and evaluate the client’s payment performance periodically.
3. Use Contracts & Fines for Late Payments
Make sure all payment agreements are written in the contract, including late fines or interest. This is not merely to pressure partners, but to be a legal basis in case of disputes and to provide a ” warning ” for clients to pay on time.
4. Open Communication If There Is A Delay
If a client starts paying late, immediately approach them professionally. Invite them to discuss a mutually agreeable repayment solution. Open communication can save business relationships and speed up the resolution of bad debts.
The Role of Billed in Preventing Bad Debt
Avoiding bad debts requires full control over spending and cash flow. Billed, as a spend management platform, helps companies monitor spending in real-time, set budget limits, and detect potential waste early.
Billed helps companies by providing full visibility into daily expenses, payment status, due dates, and priority of obligations, so that financial decisions can be made quickly and accurately.
In addition, expenses within the company are managed through an orderly and disciplined approval flow, ensuring that every transaction has passed internal controls that are in accordance with the organizational structure.
This is what allows the finance team to focus more on strategic planning and business development, rather than just focusing on tracking transactions.
Conclusion
Bad debt in business is an unavoidable risk, but it can be minimized with proper financial management, careful evaluation of business partners, and the use of digital tools like Billed and Agiled. By maintaining liquidity, setting clear payment terms, and fostering open communication, companies can reduce the chances of unpaid invoices and protect long-term business relationships. Proactive prevention is always more cost-effective than recovery after debts turn bad.
FAQs
1. What is an example of bad debt in business?
An example of bad debt in business is when a supplier provides goods to a retailer with a 30-day payment term, but the retailer fails to pay even after several months, making the receivable uncollectible.
2. How can companies prevent bad debt?
Businesses can prevent bad debt by checking the creditworthiness of clients, setting realistic credit limits, using contracts with penalties for late payments, and monitoring cash flow with tools like spend management platforms.
3. What are the consequences of bad debt on a company?
Bad debt can disrupt cash flow, increase collection costs, strain relationships with partners, and ultimately lead to direct financial losses that weaken the company’s stability and reputation.
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