Step-by-step guide to debt recovery

Keeping on top of your start-up’s finances from the beginning of your business journey is essential to help maintain a healthy cash flow and avoid late payments – 58% of UK SMEs have unpaid invoices from the 2022/23 tax year that may have a negative impact on their business.

Late payments can seriously impact a business’s cash flow, which could mean your business can’t pay suppliers, employees, or other costs when they become due.

Whilst keeping on top of your start-up’s finances and outstanding invoices is essential, there may be times when a customer has not paid an overdue invoice, and you may need to take steps to recover any money your start-up is owed.

Invoicing

Sending correct invoices and being clear on your payment terms may help reduce the risk of missed payments.

An invoice is a legal document, and the company is legally obligated to pay it unless disputed.

When sending invoices, it’s important to ensure all the details you have included – such as names and financial information – are correct.

If details are incorrect, this could lead to confusion for the customer and missed or incorrect payments.

Using a pre-made invoice template may be a good idea to ensure all the necessary details and information are easily readable and understandable, such as invoices created and issued with online accounting software.

It’s a good idea to discuss payment terms with your customer, such as the timeframe in which they have to pay the invoice and any potential late payment fees.

Doing this may help increase the chances of your invoice being paid on time.

For larger invoices or long-term client business, alternative invoicing and payment methods could be worth considering, such as setting up payment instalments.

What to do if you have not been paid

Step 1 – Send an invoice reminder

If you have sent an invoice and have not received payment within the agreed timeframe, sending a late invoice reminder may prompt the customer to pay.

This reminder may include details such as the invoice number, the agreed original date of payment, the agreed amount, what is being paid for, the payment and contact details of the payee, and what action will be taken next if payment is not made should be included to avoid any potential confusion.

It could also include a statement that the invoice is overdue and that immediate payment is required.

Contacting the customer separately from the invoice reminder, such as by phone, may be worthwhile so you can get a direct response.

If you use invoice software, you may be able to set up automatic invoice reminders to be sent to your clients if invoices become overdue.

Step 2 – Send a formal late payment notice

If you have sent an invoice reminder and still have not received payment or had any contact from the customer, you should consider sending a formal late payment notice.

This document is sometimes called a Letter Before Action (LBA).

A formal late notice outlines why you are contacting the payee, the outstanding amount your business is owed, what for and by when. This notice should also include what legal action you may take if your company does not receive payment within a stated period.

The prospect of legal action may encourage the payee to fulfil the invoice.

Step 3 – Follow up and negotiate

After issuing a formal late payment invoice, your customer may contact you regarding the non-payment of the invoice.

One reason why a customer may not have paid their invoice is that they do not have the available funds to do so.

In a situation like this, finding and negotiating a creative solution that will remove the legal pressure from your client and end with your invoice being paid could be worth it.

One way this could be done is by setting up a payment plan, where the client will pay a set amount each month over a set period until the full invoice amount has been paid back.

However, if your client does not contact you or has not had your invoice paid within the time stated in your formal late payment notice, you may wish to begin legal proceedings.

Step 4 – Seek support

Before resorting to legal action, it may be a good idea to seek support from charities and government bodies that help small businesses manage debt.

The Small Business Commissioner’s Office is an independent public body set up by Government to tackle late payment and unfavourable payment practices in the private sector, and provides access to support and advice in managing late payments.

Step 5 – Take legal action

Legal action should be considered the last resort in debt recovery.

This can sometimes be a lengthy process and damage the relationship between your business and your client if this action is taken too soon and without proper warning.

Depending on the amount your business is owed, there are two options: small claims court and debt collection.

Small claims court would mediate between you and your client, listen to both parties regarding the non-payment, and then reach a conclusion.

A successful outcome is the customer being ordered to pay the invoice amount and any additional costs, such as interest or legal fees your business has incurred.

Some courts may support the customer or propose a repayment plan to clear the debt.

Debt collection involves enlisting a solicitor who has expertise in recovering money for businesses.

A business that is unable to pay its debts when they become due is technically insolvent.

This means you can apply to the courts to wind up the non-paying company, releasing any assets that could be used to pay back any debts it owes.

Alternative payment methods

There are a number of alternative payment methods you might consider when trying to recoup a debt.

As with all financial decisions, it’s a good idea to seek independent, specialist financial advice before committing to any financial product.

Invoice factoring

An invoice factoring service provider takes unpaid invoices and pays your business a percentage of the total invoice amount when you issue the invoice.

Amounts paid vary but can be typically around 90% of the total invoice value.

The factoring company will then take on the responsibility of chasing the customer for full payment, which is paid to and retained by the company.

The advantage is it can ensure your business gets paid quickly when issuing invoices and may help improve cash flow.

Your business also won’t need to worry about chasing customers for non-payment.

However, using factoring services may reduce your overall profits and your business will be paid less than it invoices.

Sell your debt

A third-party company can purchase your outstanding debts from you in exchange for an agreed price, typically significantly less than the total amount owed, and you would no longer be associated with the debt.

The third party would then collect the total amount from your client.

Similar to invoice factoring, selling your debt could give your business instant access to a pot of cash, and this may be useful if you have accumulated a significant number of unpaid invoices or have a large amount of outstanding debt.

Employ a debt recovery agency

A debt recovery agency works to collect unpaid invoice amounts on your behalf from the customer, which could involve seizing assets to the value of the owed amount.

The advantage of using a debt collection agency is they have the resources and skills to recover funds that are owed successfully – and for some clients, notification of recovery action can prompt payment.

However, you will need to pay a fee to the agency to recover the debt, and the process can be lengthy.

With a robust invoicing and debt recovery process and proactive financial management, your start-up could be able to avoid potential cashflow issues that would negatively impact your business’s future, keeping you on track when it comes to growing your business and safeguarding client relationships.