What Is Bad Debt And How Can You Avoid It In Construction?

The construction sector is particularly vulnerable to insolvency, a primary result of the relatively slow timescales of many construction projects.

The client, the architect and the construction firm all earn their revenue at different times, and this can lead to a culture of late payments.

This is why debt recovery services are valuable in the industry; they help to reduce the cash flow problems caused by missed payments, which can spiral into insolvency, liquidation and disastrous financial circumstances.

However, not all debt is created equal in this instance, and there is good debt and bad debt, relative to their effects on a construction company as a whole.

What is bad debt? How can you tell it apart from good debt? And how can you avoid it and the insolvency that can come with it?

What Is Bad Debt?

In the world of personal finance, debt is often inevitable, so it is often split into good and bad forms of debt.

So-called “good” debt is debt taken on for investments that help to generate income or buy assets. If you take on a loan to buy or lease construction equipment for a project that can make orders of magnitude more money than is owed, that is often considered a good debt.

Conversely, good debt owed to you is money that you have raised an invoice for that you will get back before the payment becomes overdue.

By contrast, bad debt is money owed to you that is unlikely to be paid back on time, if at all.

What Are The Biggest Signs Of Bad Debt?

• Delayed Filings - Whilst not directly related to a construction firm, if a company delays filing their tax return and statutory accounts, it could be a general sign that they are in financial trouble.

• Frequent Requests To Renegotiate Repayments - If a company wants to extend the time they have to pay you back, that could be an indication of potential cash flow issues that can be a significant red flag.

• Failing to Pay On Time - A clear indicator of cash flow problems, if a client fails to meet payment milestones, it is likely that they are facing potentially existential financial issues and are less likely to repay.

• Reliance On Credit - If a client is having to borrow money to cover their operational costs or pay existing debts, that can lead to a financial death spiral.

• Payment Disputes - If there are consistent arguments about the terms of the contract, it can be a sign that a company is trying to claw back any money they have.

How Do You Avoid Bad Debt?

Whilst the circumstances of debt will vary by client, there are seven steps you can take to avoid bad debt:

• Ensure that all contracts are clear, lawful and have conditions for payment terms and consequences for late payments.

• Ensure that invoices are sent on time and recorded when payments are made.

• Establish a credit control policy or work with an agency to help you.

• Be consistent with your credit control policy. Avoid the temptation to go easy on clients who go beyond your payment terms.

• Be willing to cut ties with customers who regularly pay late or do not pay at all.

• Be aware of your cash flow forecast and the current amount of cash in the bank.

• Maintain as accurate a dataset as possible.