Timely Action & Cost of Bad Debt Management
Introduction
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 Overview of 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 How to Identify a Payment Opportunity. 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.
| Annual Sales | = £3,000,000 |
| Daily Sales | = £8,333 (360 day year) |
| Debtors | = £500,000 |
| DSO | = 60 Days |
Equation: 3,000,000 (sales) / 360 (days in year) = 8,333 (daily sales)
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 |
|
WHEN INFORMATION DICTATES: ACT ON THE FIRST DAY OF DEFAULT
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