The longer a debt remains unpaid, the greater the chance that it will never be paid.
The first step in debt management is to establish at which point an account is no longer classified as being with Credit Control, due to the time and effort required pursuing individual debtors. The primary period for standard collection is 0 - 60 days, 60 days being extreme.
With a company trading at 7.5% profit, with an account overdue for 60 days, c.50% of 'bottom line' profit is eroded.
If payment has not been received by 70 days it is suggested that you take debt management action. By the 60th day Credit Control will have allowed the customer a maximum of two 'cheque runs' or similar allowances.
Credit Control, in the period of 60 - 70 days overdue, would escalate the situation to a position where the customer would either pay the account, agree payment arrangements or ensure the customer is in no doubt as to the further action and cost about to fall upon them.
Depending of the size of the debt, a director of the debtor should be contacted immediately by a senior member of your company in an attempt to resolve the problem without further delay or cost. Ensure you have a strategy that provides options to litigation. If control is the significant part of credit control, management is the significant part of debt management.
Cost of Bad Debt
The following table is a good example of the impact of a £5,000 bad debt. The net effect is a loss of £25,000 net profit.
Indirect cost:
bad debt expense
£5,000.00
divided by net profit
(at 5%)
Cost in lost sales
£100,000
No Bad Debt
£5,000 Bad Debt
Sales
2,500,000
2,500,000
Bad debt expense
0
5,000
Sales Effect
0
(100,000)
Adjusted Sales
2,500,000
2,400,000
Gross margin (at 25%)
625,000
600,000
P & L (at 20%)
(500,000)
(500,000)
Net Profit
£125,000
£100,000
Profit lost on bad debt of £5,000
£25,000
The figures below indicate the amount of sales required to cover a write off debt:
i.e. a £500 debt at 6% profit means you have to gain sales of £8,330 to break-even
Profit
Bad Debt Amount
Margin
£250
£500
£1,000
£2,500
£5,000
2%
12,500
25,000
50,000
125,000
250,000
4%
6,250
12,500
25,000
62,500
125,000
6%
4,160
8,330
16,670
41,670
83,330
8%
3,120
6,250
12,500
31,250
62,500
10%
2,500
5,000
10,000
25,000
50,000
15%
1,670
3,330
6,660
16,670
33,330
Days Sales Outstanding (DSO)
DSO = Days Sales Outstanding: This figure represents the average time it takes you to convert sales into cash i.e. a DSO figure of 60 would indicate that it takes on average 60 days from the date of the sale to get paid.
500,000 (current debtors) / 8,333 (daily sales) = 60 (days, average to get paid)
The two highlighted cells (below - in bold) represent the reduction of the above scenario by 20 DSO, and would save about £15,000 in annual interest, with today's interest rates; plus an increase in cash flow of over £160,000.
Annual Turnover in Million £
DSO
Interest Rate %
1
2
3
5
10
1 Day
5
137
274
411
685
1370
7.5
205
411
616
1027
2055
10
274
548
822
1370
2740
12
329
658
986
1644
3288
15
411
822
1233
2055
4110
1
2
3
5
10
5 Days
5
685
1370
2055
3425
6850
7.5
1027
2054
3082
5137
10274
10
1370
2740
4110
6849
13700
12
1644
3288
4932
8219
16438
15
2055
4110
6164
10274
20548
1
2
3
5
10
10 Days
5
1370
2740
4110
6849
13700
7.5
2054
4108
6164
10274
20548
10
2740
5480
8220
13698
27400
12
3288
6576
9864
16438
32876
15
4110
8220
12328
20548
41096
1
2
3
5
10
20 Days
5
2740
5480
8220
13698
27400
7.5
4108
8216
12328
20548
41096
10
5480
10960
16440
27396
54800
12
6576
13152
19728
32876
65752
15
8220
16440
24656
41096
83092
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