For any company, recovering unpaid invoices is an essential part of ensuring the long-term future of its business. When an invoice goes unpaid, there are various solutions available to the creditor, ranging from amicable approaches to legal action. But when the customer turns out to be insolvent, the debt is lost, and the consequences can be very damaging if the amount is significant. That's why the most important thing is to protect yourself against the potential insolvency of your customers (and yourself!). Fortunately, there are solutions.
What is insolvency?
Insolvency refers to the inability of a natural or legal person to meet its financial obligations as they fall due. In the case of a company, this occurs when its debt exceeds its equity and assets. Put simply, its assets are insufficient to pay its supplier debts, bank loans and taxes.
This critical financial situation generally leads to a declaration of suspension of payments but insolvency is not necessarily synonymous with bankruptcy: rescue solutions can sometimes be envisaged before reaching this extreme. The company concerned should react as soon as possible, so that it can take precautionary measures.
Once insolvency has been established and there is no obvious solution, the consequences for creditors are potentially deleterious: depending on the size of the invoices concerned, their own financial health could be undermined. All businesses should therefore take steps upstream to cover the risk of customer insolvency, for example by taking out a credit insurance policy.
Immediate or widespread insolvency
- Cash flow insolvency, when a company is unable to pay its short-term debts due to a lack of available cash. In this case, an extension may be granted to allow the company to rectify the situation if its financial outlook is positive.
- Balance sheet insolvency occurs when the value of a company's assets[1] is less than the value of its liabilities[2] , which means that even if it sold all its assets, the company would not be able to repay its debts. This second case leads to bankruptcy.
The main causes of business insolvency
To fully understand insolvency - and protect yourself from it - you need to learn to spot the situations and signs of risk. Caught up in the day-to-day running of a business, it's easy for an entrepreneur to reach a point of no return before realising the seriousness of the situation. Several factors can lead a business to insolvency, and in reality there are many combined causes.
Poor financial management
Managing cash flow, making the right financial forecasts, adjusting the size of stocks: the financial management of a company is often complex, and the slightest mistake can have major consequences.
Over-indebtedness
It may be tempting to take out loans with banks or financial partners in order to grow faster. Be careful, however, because an accumulation of loans can backfire and place the company in a situation of over-indebtedness, stifling its cash flow and preventing it from paying its debts to suppliers. This situation needs to be identified as soon as possible, so that a plan can be devised to spread the repayments over a period that is financially viable.
Lower revenues
A significant drop in sales can make it difficult to pay debts. Loss of customers, loss of market share, increased competition: a company must always remain attentive and adjust its supplies as quickly as possible to changes in sales volumes.
Unfavourable economic conditions
More surreptitiously, an economic crisis, sudden regulatory changes or a sudden rise in interest rates can have a negative impact on a company's financial health.
Bad strategic decisions
Risky investments, poorly planned expansions or mistaken strategic decisions can also contribute to insolvency. Failure to adapt to market changes can precipitate this situation.
Knowing how to protect yourself against insolvent customers or those at risk of becoming insolvent
To ensure the long-term future of your business, you simply need to avoid working with customers who are in poor financial health. Certain preventive measures will be highly effective:
Solvency checks
Before committing to new customers, it is prudent to check and monitor their solvency by means of credit reports, analysis of their financial statements or by asking for commercial references. Companies specialising in business information can be commissioned to carry out these checks.
Clear and precise contracts
Contracts signed with customers must be clear, particularly with regard to payment terms, which will include clauses on penalties for late payment and possible action in the event of non-payment.
Proactive receivables management
A rigorous debt monitoring system is essential, unless you choose to outsource debt collection. Sending payment reminders before the due date, maintaining regular contact and making immediate contact at the first delay in payment are the right reflexes for understanding the situation and negotiating solutions.
Taking out credit insurance
Credit insurance protects a company against losses due to customer insolvency. It generally covers a percentage of unpaid receivables and includes indemnification services.
Diversification of the customer portfolio
Depending on a limited number of customers is dangerous. A larger number of customers from as wide a range of sectors as possible is a source of protection for the company, making the failure of one customer or the crisis in one sector less of an impact.
Signs that your customer is at risk of insolvency
Protecting yourself against non-payment starts with identifying customers who are potentially at risk of becoming insolvent. Here are a few warning signs:
- Your customer pays your invoices increasingly late;
- He is seeking to renegotiate the terms of the contract;
- Other suppliers refuse to continue working for him;
- It takes out loans that are essential for the continuation of its business;
- Its payroll is falling abnormally.
Of this non-exhaustive list of worrying signs, the first are easy to spot. If you have the slightest doubt, don't hesitate to order a credit check from specialist companies: it's important to protect yourself so that you don't follow the same path!
What to do when faced with an insolvent customer and an irrecoverable debt
Despite all the precautions you take, it is possible to find yourself faced with an insolvent customer. Here are a few steps to follow in such a situation:
#1 Communication and negotiation
The first step is to communicate with the customer to understand their situation. The aim will be to negotiate an instalment plan or to agree a partial settlement of the debt. Even if a company is insolvent, it generally still has assets that it can use to pay part of its debts, and positive, sympathetic communication can help to put it at the top of the list of suppliers to be paid.
#2 Amicable recovery
If negotiation fails, it is essential to try to recover the debt amicably and through an official procedure, by means of reminder letters and formal notice. Here again, a debt collection agency can take over if necessary.
#3 Legal recovery
If amicable attempts are unsuccessful, judicial recovery is the next step - and attempts at amicable redress will have to be justified. A lawyer can be of invaluable assistance in obtaining a payment order or the opening of receivership proceedings against the customer. His presence will also be compulsory in the event of an objection for a debt of more than 10,000 euros€ .
#4 Provisioning of doubtful debts
The fourth step, which may be considered at any time depending on the debtor's confidence in paying what is due, is the provisioning of doubtful debts, which consists of admitting that there is a probability that the debt will not be recovered, and preparing for this. In this case, the invoice is recognised and written down in the accounts using the following entries:
- Debit to account 416 (doubtful debts),
- Credit to account 411 (trade receivables).
This makes it possible to measure the impact of the potential non-payment on the company's financial situation, and to take precautionary measures quickly.
Doubtful debts should be distinguished from irrecoverable debts, which presuppose a definitive loss of the debt (and not a mere probability) and open up the possibility of recovering VAT.
#5 Lessons learned and adjustments
Finally, this experience should enable us to adjust our commercial practices to limit the risk of such a problem occurring in the future. Reviewing solvency verification processes, improving contractual terms and conditions and strengthening receivables management are good reflexes.
When in doubt, assign your claims!
If, despite your best efforts, you still have doubts about your ability to collect certain debts, you should know that it is possible to assign them to specialist companies. These companies will then take charge of collection, in return for a commission representing a percentage of the invoice entrusted to them.
Insolvency is a major risk for any business, but it can be managed and minimised by taking appropriate preventive measures, in particular with a reliable player such as Coface, a French company and a major player in trade credit insurance worldwide.
[1] A company's assets are its total assets. These include buildings, equipment, receivables, registered patents, etc.
[2] Liabilities correspond to the company's means of financing its assets. They are made up of shareholders' equity (fixed liabilities) and debts (current liabilities).
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