Assessing New Customers To Help Minimise The Risk Of Bad Debt

Preventing bad debt is a commercial necessity and begins long before an invoice is issued. For UK businesses of all sizes, conducting meaningful customer due diligence before entering into any commercial relationship is a vital step in protecting cash flow, reducing risk and strengthening enforcement of contractual rights.

Identifying your customer

The first priority is to accurately identify the party you intend to carry out business with. Whether they are a limited company, partnership or sole trader, it is essential to establish their correct legal entity name, status, and, if relevant, registration details and reflect them fully in your contract. This identification is solely to establish the identity of the prospective customer and is not sufficient to fulfil compliance obligations which require wider checks and verification.

Financial reliability is a further consideration. For example, by carrying out credit checks through commercial agencies such as Equifax or TransUnion, it can reveal a customer’s payment history, unsatisfied judgments, and any signs of financial distress. Where appropriate, requesting trade references or banking details can provide further insight into a prospective customer’s commercial behaviour. In higher-risk situations, you may wish to consider requesting personal guarantees from company directors or individuals associated with limited liability entities, such as members of LLPs, to strengthen your organisation’s position. Personal guarantees have specific formalities to ensure enforceability; legal advice is recommended if personal guarantees are being considered.

Strengthening your contractual position

It is also important to ensure that your contractual documentation supports your commercial objectives by including provisions such as:

These provisions not only encourage prompt payment but also provide a legal foundation for enforcement if necessary.

Internally, organisations should consider a robust payment reminder process, monitor payment behaviour closely and set credit limits for new customers. These limits can be reviewed and adjusted over time, but caution is advisable at the outset. Warning signs such as delayed payments, frequent changes in contact personnel, or requests to alter agreed credit terms should prompt a reassessment of the customer’s risk profile.

Early engagement with customers when non-payment occurs, friendly escalation followed by formal notices and a robust approach for persistent defaulters, including enforcement of contractual terms, should all be considered and incorporated as part of your internal processes.

Comment

The above relates to some practical steps businesses can take to help minimise the risk of bad debt. By investing time in understanding who you are doing business with, both legally and financially, your business can reduce exposure to bad debt, improve recovery outcomes, and maintain a stronger commercial footing. Additional due diligence activity is required by UK businesses to ensure regulatory and statutory compliance, depending on, for example, the size and sector of the business; however, such due diligence activity requirements are not covered in this blog.