Bad debt has become a ubiquitous term, seemingly affecting everyone and everything. It pervaded the financial system during the crisis, from the debts which U.S. homeowners could not afford to repay, to the toxic assets of the banks, which were passed to taxpayers. In the malaise that is bad debt, we may have forgotten what it actually is. It is money that is owed but will never be recovered, usually as a result of an inability to pay.
SMEs can face fatality if a debt turns bad. According to our latest SME Confidence Tracker, a quarter of SMEs experience bad debt [1] and a similar proportion see their profits fall as a result. If left unchecked a bad debt can mean the end of your business. SMR Supplies Ltd, a Merseyside computer firm, was owed €240,000 from a customer who went into administration. Without bad debt protection the company would have gone bankrupt.
Businesses that may have become more distant and removed from their end customers, as they approach the M in SME with revenues of £1 million, seriously struggle with the issue of bad debt, with a third affected. This is significantly higher than the 1 in 4 across all UK SMEs.
There are some easy lessons for UK SMEs to learn from this bad debt parable:
Know your customer - Take the time to regularly check in with your key customers and see what you can find out about the strength of their business
Protect yourself and your business - Bad debt protection will prevent bad debt creeping up on you when you least expect it.
Diversify your business model and assess risk - Assess your capacity for loss. Ask yourself, “What can I afford to lose? How would I cope if my largest customer went bust?” Some well-timed soul searching might reveal that you are better off diversifying away from just one customer.
Bad debt can feel remote and ephemeral to a small business owner, but we are actually surrounded by it each and every day. Companies will always go bust, simply because they do not last forever – nor would it make sense for them to do so. In the constant evolution of business, tomorrow’s technology replaces today’s. This is the business circle of life.
In this sense, bad debt is as old as the hills, and it will also never go away. Although this risk is ever-present, it is actually very easy to protect yourself against it. You cover everything else that affects your business. So why not take the simple step of protecting your livelihood: the business you’ve built from scratch?
[1] The SME Confidence Tracker surveys over 1,000 of the UK’s small and medium sized businesses on a quarterly basis. The Tracker charts the confidence of business owners and senior decision-makers managing businesses with an average turnover of £1.2 million.