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Seven Risk Mitigation Techniques for Handling Customers in Financial Distress




SEP 19, 2023

Most businesses put up with customers that are chronic slow payers. Many of these customers pay late, but not seriously late, and the amounts involved do not create an exposure problem. There will always be a few customers, however, who consistently delay and end up paying large balances substantially beyond terms.Despite what these customers may tell you, the reason for their payment behavior is a lack of financial resources.

(Photo by Elisa Ventur on Unsplash)

There are several situations that might explain this behavior:

  • Companies that are under-capitalized often rely on their accounts payable (their suppliers’ receivables) as a source of capital by delaying payment.
  • Other companies start living hand to mouth when their sales trend downward, and unless sales pick up its hard for them to catch up on their payments.
  • Some sort of unexpected challenge such as a natural disaster, regulatory problem, or a major lawsuit can also put a company behind the eight ball and affect their ability to pay their suppliers.

When a customer’s financial resources are limited or otherwise constrained, the likelihood that you will never be paid all of the money you are owed increases substantially. Commercial bankruptcies have been trending upward for most of this year, so it is likely some of your customers are in a downward spiral, if it has not yet shown up in their payment pattern. Recognizing that a customer is in distress putting your receivables at risk is the first step in ameliorating the situation. For more on Red Flags click here.

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What are Your Options?

Now that you understand that your customer has become a liability, it’s time to review their credit worthiness again so you can make informed choices. Order a new credit report, request updated financial statements, and re-check the references provided when they first applied for credit.

This should be done as part of an ongoing conversation with the customer to convince them to pay you sooner. The message is that you are trying to work with them, which requires they be open with you. At the same time, you need to make it clear that further delinquency won’t be tolerated.

From this conversation, you will learn how perilous the bad debt risk is with this customer, and how urgent your reaction must be. Based on those customer insights, here are your options:

  1. Do Nothing and Hope for the Best:One option is to continue on in the current mode, hoping that over time, the profit and cash you receive will exceed the ultimate loss you incur when the customer fails or drops you as a supplier. This is essentially a “do nothing” option and seldom works. The only time you should go this route is if the customer suffered a one-time event from which you expect them to recover over time.
  2. Raise Their Prices:When you have a high credit risk customer, you should be charging them the highest price possible. This will help compensate you for the high risk you bear and reduce the ultimate loss you may suffer. Such risk-based pricing is facilitated by grouping all high credit risk accounts into a classification that gets charged top dollar for your goods and services.
  3. Reduce Your Exposure:This can be done unilaterally. It involves intensive management of the customer’s total receivable balance supported by a substantial reduction in their credit limit. Every order from the customer should be put on credit hold while you negotiate a payment of their old debt. To reduce your exposure, each payment needs to be larger than the amount of any order you release. This has the effect of reducing the aggregate AR balance owed by the customer. This is time consuming, labor intensive, and generally engenders ill will between you and the customer. Unfortunately, this is often necessary, because if you stop supplying them, they’ll probably stop paying you. However, if you can receive a steady stream of payments that continually reduce your AR exposure to this customer, it may be the best outcome you can achieve.

Please feel free to share this newsletter with your small business customers . . . it just might help them pay you sooner!


  1. Set up a Payment Plan:This is another way to reduce your exposure over time, but it requires a cooperative customer. Instead of having to negotiate the release of every order, you negotiate a comprehensive payment plan that also sets parameters for processing orders as long as the customer is adhering to the plan. One way to do that is to require cash in advance or a down payment based upon a set percentage for each new order. Ideally, the customer will agree to sign a Promissory Note, which in the event of default can be taken to a judge with the assurance you will be granted a judgement against the debtor since this document is prima facie proof of the debt.
  2. Mitigate the Risk with a Financial Instrument:Involving a third party with strong credit is a good way to get security on the debt owed you. This should be done before the customer becomes distressed, which can make it very difficult to get third party support. This additional security can be in the form of:
    • Credit Insurance– assuming you can find a Credit Insurer to cover a specific customer, you will be covered for most of your exposure to the customer (excluding policy deductibles and co-pays) in return for paying an insurance policy premium. Chances are, however, in order to cover this one account, you will need to cover your entire portfolio or a substantial segment of your AR — click here for a previous post about credit insurance.
    • An Irrevocable Letter of Credit(LC) confirmed by a solid bank, with your firm named as the beneficiary. The bank will pay you if your customer defaults. Oftentimes, the bank will require your customer to keep the funds on deposit, or have sufficient borrowing capacity at the bank issuing the LC.
    • A Guarantyof the debt owed you, made by a third party such as the owner of other principal of the customer’s company (personal guarantee), or made by another company (often a parent company – corporate guarantee). With personal guarantees you may need to also get the wife’s signature (joint personal guarantee) and you need to know whether the customer resides in a Community Property or a Tenancy by the Entirety state — you’ll probably want your attorney to help you sort out the details.
    • Purchase Money Security Interest– A PMSI is a legal claim under Uniform Commercial Code (UCC) regulations that allows a creditor to either repossess goods sold on credit terms or to demand repayment in cash if the borrower defaults. It gives the creditor priority over claims made by other secured and unsecured parties. To be effective, the goods you sell should be easily identifiable from other products the customer purchases in order to avoid “co-mingling” with those products purchased from other entities and be something the customer would normally sell from inventory. An attorney or a UCC filing firm can help you set up a PMSI. For a more in depth look at UCCs and collateralization go here.

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  1. Sell the Receivable:AR Finance has become a growth industry, but is typically used by larger enterprises. The good news for small companies is that there are a growing number of Fintech firms that will offer Point of Sale financing for B2B transactions. The trick will be finding a finance company that will accept the AR of your high risk customers. Your chances may improve if you offer this potential financial partner the opportunity to finance all your sales or a specific call thereof. Financing AR has many cash flow benefits and the cost can be quite modest. Most forms of AR Financing are essentially different forms of factoring, but now enhanced by digital technologies.
  2. Cut Your Losses:Send a letter to the customer demanding payment for all balances due and stating that failure to pay by a specified date will result in the customer (who is now a debtor) being referred to a Collection Agency or Attorney. This is commonly known as a 10-day demand letter. Before the letter is sent any orders should be put on credit hold (should they pay, which does happen infrequently, you will want to seriously consider future sales on credit terms). Sending a demand letter will likely end your commercial relationship with the customer, but may be your best chance of recovering the AR.

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In Summary . . .

Financially weak customers pose a serious threat to the revenue, cash flow, and profitability of your firm. Recognizing the degree of financial weakness and risk of loss is the first step to mitigating the impact.

As outlined above, there are a range of actions you can take to reduce the negative impact on your firm. In many cases, you may have to try several of them to find one that works. Also, what works with one account won’t necessarily work with another, so it is best to always be seeking to broaden your capabilities for dealing with problem accounts.

Another issue with problem accounts, is that they are a distraction. Dealing with a customer’s chronic credit problems takes you away from activities that will help grow your business. Sometimes its best to simply cut your losses and refocus on those customers that can help your company achieve its goals.

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