Securing the collection of unpaid invoices is crucial for maintaining a company's financial stability. When faced with non-payment, creditors have several options, but if a customer is declared insolvent, the consequences can be severe, potentially resulting in a total loss of the claim. To avoid such situations, it is essential to take precautions against both customer insolvency and one's own business risks. Fortunately, solutions exist.
Understanding insolvency
Insolvency is defined as the inability of a company or individual to meet financial obligations when due. In the case of a business, this occurs when liabilities exceed the value of assets and equity. Simply put, the company lacks the necessary resources to pay its suppliers, banks, or tax authorities.
This situation can lead to a declaration of suspension of payments, but insolvency does not always mean bankruptcy—solutions can sometimes be found before reaching that critical stage. Acting quickly is essential to anticipate and implement appropriate protective measures.
When insolvency is confirmed, and no resolution is possible, the impact on creditors can be significant. Depending on the amount of outstanding debt, it can jeopardize their own financial health. Therefore, it is strongly recommended to secure against the risk of customer insolvency, particularly through trade credit insurance.
Types of insolvency: immediate vs. generalized
Insolvency can take two primary forms:
- Cash flow insolvency: When a company cannot meet its short-term obligations due to a lack of liquidity. In such cases, rescheduling payments may be sufficient if financial prospects remain positive.
- Balance sheet insolvency: When the total value of a company’s assets1 is lower than its liabilities2. This means that even by liquidating assets, the business cannot repay its debts, often leading to bankruptcy proceedings.
Main causes of business insolvency
To prevent insolvency, it is important to understand its causes. Business leaders often find themselves in critical situations before fully grasping the severity of the issue. Common factors include:
- Poor financial management: Inadequate cash flow forecasting, incorrect projections, or poor inventory management can weaken a business.
- Excessive debt: Some companies take on too many loans to finance growth, but over-indebtedness can strangle cash flow and complicate supplier payments.
- Declining revenue: A drop in sales due to lost customers or increased competition can make debt repayment difficult.
- Adverse economic conditions: Economic crises, sudden regulatory changes, or rising interest rates can impact businesses.
- Risky strategic decisions: Poorly planned investments or failure to adapt to market trends can accelerate insolvency.
Protecting your business from insolvent customers
To mitigate the risks associated with unpaid invoices, consider these best practices:
- Analyze customer solvency: Before working with a new client, assess their financial health using credit reports or financial statement analysis.
- Draft clear contracts: Contracts should clearly define payment terms and include clauses for handling potential delays.
- Optimize debt collection processes: Implement a rigorous receivables management system. Sending payment reminders before due dates, maintaining regular communication, and responding immediately to late payments are key practices.
- Obtain trade credit insurance: This reduces the financial impact of unpaid invoices and provides access to indemnification services.
- Diversify your client base: Spreading risk across different sectors helps minimize the impact of a single customer's failure.
Recognizing warning signs
Preventing unpaid invoices starts with identifying clients at risk of becoming insolvent. Key indicators to monitor include:
- Increasingly frequent late payments;
- Attempts to renegotiate contract terms;
- Refusals from other suppliers to collaborate;
- Heavy reliance on credit to sustain operations;
- Unusual workforce reductions.
While this list is not exhaustive, many of these signs are easy to spot. If in doubt, seek assistance from specialized firms to conduct solvency investigations. Prevention is always better than dealing with the consequences of non-payment.
How to handle an insolvent client and an unrecoverable debt
Despite taking all necessary precautions, encountering an insolvent client remains a possibility. Here are the key steps to manage the situation:
- Dialogue and negotiation
Start by communicating with the client to understand their situation. The goal is to reach an agreement, such as a staggered payment plan or partial debt settlement. Even in cases of insolvency, companies often have mobilizable assets to pay part of their debts. A constructive approach can encourage the client to prioritize your payment.
- Amicable debt collection
If negotiations fail, initiate an amicable recovery process by sending payment reminders, followed by a formal demand letter if necessary. A collection agency can also step in to maximize recovery chances.
- Legal action
If amicable collection is unsuccessful, legal proceedings become the last option. It is essential to prove that amicable efforts were made. A lawyer can assist in obtaining a payment order or initiating bankruptcy proceedings. Legal representation is required for disputed claims exceeding €10,000.
- Provisioning doubtful debts
Depending on the assessment of the situation, it may be prudent to provision doubtful debts. This accounting approach anticipates potential non-recovery by recording:
- Debit: Account 416 (doubtful accounts)
- Credit: Account 411 (clients)
- Review and adjust processes
Such situations provide opportunities for improvement. Reviewing solvency verification procedures, strengthening contract terms, and optimizing receivables management can help prevent future non-payments.
An effective solution: debt assignment
When in doubt, consider assigning debts to a specialized company that will handle recovery on your behalf.
At Coface, we recover your outstanding debts both in Switzerland and internationally, with a results-based pricing structure.
👉 Contact our experts for a personalized quote!
Insolvency remains a major risk, but by adopting best practices and partnering with reliable experts like Coface, you can manage it effectively and protect your business in the long run.
1 A company’s assets include its entire estate, such as buildings, equipment, receivables, and registered patents.
2 Liabilities represent the means used by the company to finance its assets. They consist of equity (fixed liabilities) and debts (current liabilities).
