Small business owners have to be extremely versatile. They're chief marketing officers and salespeople one day, operations managers and human resources heads the next. Because marketing and sales generate the revenues that keep the doors open, many entrepreneurs devote the lion's share of their energy to those responsibilities. In the chaos of day-to-day operations, however, the importance of turning a sale into actual cash is often overlooked.
As the old saying goes, "Revenue is vanity, cash flow is sanity, but cash is king." Unfortunately, many business owners underestimate the importance of collecting what they're owed. According to the Small Business Administration, cash flow is the "lifeblood of a business and critical to its growth." It is the single most important factor in a company's survival.
The responsibility of debt collection is often delegated to accountants, and while that's a logical choice, a truly effective strategy requires your input, direction, and support. A sale without immediate cash payment constitutes a debt on company books, plain and simple. Your strategy should be to turn that debt into cash as quickly as possible.
Debt Collection Strategies
An effective company debt strategy involves multiple departments and includes the following components:
- Decisions about who may be extended credit upon a sale in lieu of cash payment.
- Internal recording and communicating of transaction details.
- Communications with customers who owe the debt in compliance with federal and state laws.
- Collection, including any negotiations, of debts.
- Oversight and necessary adjustments to continuously improve the ratio of payments to sales and decrease the time between sale and resolution.
Your debt collection strategy might limit collection activities to internal departments or to vendors you've outsourced to. However, as a business owner, if you collect, transfer, store, or communicate private consumer data, you are subject to consumer protection laws that cannot be transferred to a third-party vendor. Even if you only transfer some duties to vendors, you are responsible for their activities under existing law. Ask your attorney about the details of this liability and ways you can minimize your risk.
Keep the following tips in mind as you implement and improve your debt collection system.
1. Avoid Collection Problems with Pre-Sale Research
Many small businesses are so eager to make a sale that they fail to determine whether or not the new customer warrants an extension of credit. If you are in a low-margin business, however, the impact of an unpaid debt can bring your company to its knees. Unfortunately, issuing credit is likely necessary for such businesses for competitive reasons, but it always makes sense to reduce the risk of bad debt as much as possible.
The decision whether to extend company credit is critical to the way you operate your business. If you sell big-ticket items or services to businesses, extending credit is almost mandated since companies generally pay bills on a regular cycle. Even when bills are paid in full at the end of the month, though, your company is at risk for non-payment during the period the debt is outstanding.
On the other hand, if you accept credit cards or debit cards and comply with the card's approval policies, you effectively transfer any credit risk to the card issuer. Of course, this adds the additional expense of issuers' transaction fees. Many small businesses establish a dual credit system, requiring consumers to pay with cash or card while extending credit for business purchases.
If your company extends credit in its own name - letting customers pay after they have received the product or service - establish a company policy that defines who gets such credit and base it on verifiable business or consumer data. A full report or credit score is needed in this case - they can be purchased on an individual or subscription basis from a number of sources. For example, Experian offers tiered reports on businesses from low- to high-risk, as well as individual credit reports and scores.
Once you have decided which classes of customers should receive credit, establish a credit approval process with detailed procedures including the dollar level of their approval authority. Exceptions to this process should be few and far between.
Experian offers a complete decisioning solution called DecisionIQ which resides within our BusinessIQ suite of tools. DecisionIQ enables you make quick, consistent credit decisions across your organization. With DecisionIQ you can establish your own rules and credit limits to create unique policies for different areas of your business. Streamlining the decision-making process allows you to focus mainly on customers requiring manual review.
2. Develop and Communicate Credit Guidelines
Once you have created credit extension and approval processes, communicate your guidelines to your customers. In other words, if you are going to offer credit, turn it into a win-win for the both of you. Extending credit may give you a competitive advantage or help boost sales - make your guidelines and processes available on marketing and sales brochures, your website, order forms, and other materials available to the public.
Engage in written contracts liberally, especially if the dollar amount is significant. Each contract should detail the specific terms of the sale - when the product or service is delivered, when payments are to be made, where they should be sent, and any finance charges that might be applicable to late payments. Detail your right to pursue court action in the event of default, and include a clause that the defaulting customer is liable for court costs and fees as well as your attorney's fees if legal action is necessary. Have the customer sign and date the contract in front of a witness, if possible. Keep in mind that it's your money at risk - customers should understand that this process is necessary to protect your business.
Keep in mind you can vary the terms of each deal based upon the credit report you use to evaluate customers' creditworthiness. For example, you may require a larger down payment, a shorter payment term, or a higher interest rate. However, if you deny credit or use "risk-based pricing," you must notify and provide specific information to consumers to protect their legal rights.
3. Implement Early Payment Options
Consider asking for a full or partial payment up front if you provide a short-term service like cleaning, which requires an expenditure for materials, or a long-term service such as computer programming. Some businesses have returned to the practice of lay-away, collecting all of the money for a product before delivery. Surprisingly, some consumers prefer lay-away as it avoids debt, eliminates interest, and provides greater flexibility. If you offer a continuous service, consider subscription sales with automatic payments deducted from the customer's bank account or credit card - it minimizes the cost of collection and facilitates cash flow planning for you and your customers.
When extending credit, even in the short-term, consider offering a price discount for immediate payment. Some companies effectively use a carrot-and-stick approach - a discount for payments made before they are due and the imposition of a fee for late payments. Be aware, however, that big companies often take the discount despite making late payments, forcing you into a confrontation with large customers over their payment policies. Such companies are especially adroit at cash management - speeding up collections while delaying payments - especially when there is an imbalance of market power.
4. Standardize Collection Processes
Debt collection begins with your invoices and includes monthly statements and other communications with customers. Be sure your invoices are numbered with billing terms, due date, and payment address all clearly visible. When payment is received, send a confirmation and a thank-you for the business. If it is not received on the due date, implement a staged process of communications including physical mail, emails, and phone calls. If your business revolves around personal sales, include the salesperson in the collection process - often they have personal relationships with clients and can facilitate collection if other efforts bog down.
It is in your interest for customers to think of you and your collection people as a small business, rather than a debt collector. Customers might be suffering one-time problems with cash flow and your willingness to work with them is likely to create customers for life. However, if you are in a business and jurisdiction where you can file a UCC-1 to perfect your security interest or a worker's lien on your product or service, be aware of deadlines and the rules affecting their use.
Experts emphasize that the key to collection is persistence. Creditors usually want to pay their bills, but occasionally run into situations where it is difficult to do so. Be prepared to negotiate. If you're able, consider substituting a note with a series of payments for an account receivable setting up a payment plan. Some debtors offer a payment of 30% to 50% of the amount owed for a full release from liability. This strategy is particularly useful if your sales records or security interests are unclear or deficient.
Experian offers a service called Delinquency Notification Service which leverages the power of the Experian® brand to motivate your slow paying commercial customers who are behind on their accounts to pay before you send them to collections. Delinquent customers receive a letter on Experian letterhead indicating their current obligations and instructions on how to pay you. This cost-effective letter service is proven to increase receipt of payments from delinquent accounts.
Debt collection is not a personal process and should be handled professionally by all parties. It is mandatory that you align, develop, and operate your collection processes in compliance with state and federal laws regulating conduct and communications between creditors and debtors. If you retain third parties to collect payments on your behalf, you are liable for their actions and behavior.
5. Monitor and Manage Your Debt Portfolio
Cash flow requires constant monitoring and management of your accounts receivable. As owner, you should get, at a minimum, weekly aging reports for all accounts receivable. Sort your receivables into various categories according to length of delinquency and an objective estimate of likely collection. This allows you and your people to devote their time most effectively - spending $500 in employee time to chase $100 in receivables doesn't make much sense.
Keep each customer's records up to date, and update your credit reports on active customers annually. At the same time, however, purge your systems of any personal or confidential consumer information once it is clear that the client is no longer a customer. Keeping outdated consumer information is like having a time bomb in your records - it doesn't help your business and you never know when it might blow up in your face.
For Experian BusinessIQ customers, you can get the money you are owed by using the collections in BusinessIQ to find alternative contact information, send collections letters and even provide tools to help your debtors understand their credit. Often, people who owe money can be hard to track down, business locations may shut down and phones may be disconnected, the collections recovery tool in BusinessIQ provides access to alternative telephone numbers, contact names and addresses. The collections tool includes some great reports including a prioritization grid to help you quickly determine who’s most likely to pay based on payment history and credit lines. Once you target your payers, use Experian’s delinquency notification service to motivate prompt payment. The service mails letters on Experian letterhead to delinquent customers on your behalf. Businesses who have used the service find the power of the Experian brand frequently inspires debtors to respond, which means more money recovered and applied to your bottom line. Along with these mailings, your debtors receive 60 days free access to their own business credit report and score. This helps them understand how their payment behaviors impact their credit.
6. Never Beat a Dead Horse
There comes a point in every collection effort where you can anticipate the final result, either positive or negative. By that time, you should know whether a default is due to circumstances beyond customers' control or if they are simply refusing to pay. At that point, you can either continue your collection efforts or stop throwing good money after bad and try to recover as much as you can.
As an alternative to a futile legal action, consider selling any apparently uncollectable, delinquent accounts to a factor for pennies on the dollar, usually 5% to 10% of the amount owed. The sale should transfer all of your rights to the purchaser in return for a release of any liability for your past or the purchaser's future collection efforts. Consult an attorney before the sale to ensure you are liability-free and to get directions on how to appropriately dispose of the debtor's personal information in accordance with privacy laws.
Effective debt collection is a critical element of running a successful business. As with many potential obstacles, it is better to anticipate problems and develop solutions before they arise than to try and solve them in the midst of chaos. Abuses of consumer privacy have resulted in restrictive, even hostile regulations on debt collection practices. As always, the best strategy for a small business owner is to provide excellent products and services, know your customers well, and treat them as you want to be treated. What is your debt collection strategy?