As a general rule of thumb, any business can expect to write off between 3% and 5% of debt as bad. That’s if the business’s receivables are managed properly. If not, that percentage will be much higher.
For any small business, especially one that’s in its first couple of years of operation, cashflow is a paramount consideration. Many small businesses fail simply because they run out of cash during this period. So don’t throw away money that’s owed to your business just because its collection is unpleasant. The very survival of your business may depend on this cash.
In this article we consider whether you should extend credit and, if so, what processes you should implement to maximize your chances of getting paid.
Should you Extend Credit?
You might want to have a strict payment-up-front or on-delivery payment policy, but the realities of today’s business environment are such that, in order to remain competitive — and make a sale, you may have very little choice about your policy.
Assuming you have no real alternative other than to extend credit, the establishment of a policy about the extension of credit will be essential to your business’s success.
How rigorous your policy is will depend on how much money you make on each job. If you perform a service or sell products worth several thousands of dollars, you’re obviously going to be more concerned about the creditworthiness of your customer than if you’re only talking about a $50 sale.
So what are the considerations you should take into account for major orders?
When you consider the character of your customer, focus on the willingness of the customer to pay debts.What do you know about your customer? What is the history of the business, and how experienced is its management team? Does the firm have a history of litigation for unpaid debts? Does it (or any of its principals) have a history of insolvency?
2. Financial Capacity
Here we’re concerned not with the customer’s willingness to pay debts, but with its capacity to do so. So find out about the financial position of your customer before you decide to extend credit.
How do you get the information you need to determine your customer’s character (willingness to pay) and financial capacity (ability to pay)? Ask for this information in an Application for Credit form that you develop for this specific purpose. Any prospective customer who’s reluctant to complete such a form should be treated with caution. Any reputable organization will understand your concern to only extend credit to creditworthy applicants.
And don’t just accept at face value the information that you are provided with. Carry out credit checks (try Equifax in the case of individuals, and Dun & Bradstreet for corporate credit checks). Also check with your customer’s bank and, two or three of their customers. You should ask for credit referees such as these on the Application for Credit form.
If the result of any of these enquiries is even slightly negative: be cautious. And if you’re just not comfortable enough to extend credit to a particular customer, don’t. Don’t be coy here. This is your business’s livelihood you’re dealing with. In such cases, require payment prior to shipment or prior to the performance of services.
Once you have decided to extend credit to a particular customer, make sure your supply terms are crystal clear.
Your supply agreement should cover:
- In the case of the provision of services, what services are you to perform for the customer? In the case of sale of products, what are you selling? In other words: what is the subject matter of the contract?
- The fee for your services or price for your products.
- When delivery will occur.
- When ownership of goods will pass. If you’re shipping goods to your customer, consider including a retention of title clause in your supply terms. This clause will have the effect that ownership of the goods will not pass to the customer until payment is made. This means you can, at least in theory, repossess the goods if you don’t get paid.
Note this will usually only be effective if the goods can be specifically identified as belinging to you. If the goods in question could have been sourced from any number of souppliers and can’t be identified as having come specifically from you, a retention of title clause may offer little real protection. However, if you sell goods that are identified with serial numbers, or you’re the only vendor of a particular product, such clauses are effective.
- When payment is due. In the case of major jobs, consider requiring part payment up front with the balance due on completion, or in stages throughout the project.
You should issue your invoice upon delivery of the goods or completed service (unless you’re receiving payment in instalments throughout the project, in which case you can issue an invoice at each point in the project at which payment is to be made).
Make sure your invoice is clearly laid out and easy to understand, and that payment terms are unambiguous. There should be no doubt when payment is due. For example, "Payment is Due on Receipt", "Net 30 days" etc.
If you intend to impose a late payment penalty if the invoice isn’t paid on time, make sure this appears on the face of the invoice, along with details of any discount you offer for early payment.
Most customers will simply pay you when the payment is due. Others, unfortunately, will not. So you need to have an established process to ensure that you get paid.
To begin with, pay attention to your receivables position. Set aside time each week to review and take action on outstanding accounts. This will undoubtedly be one of your least favorite activities. No-one likes calling up debts. But don’t put this off: you’ll have the best chance of getting what’s yours if you act quickly and decisively, before a debt has the chance to become doubtful, let alone bad.
Monitor your receivables and be on the lookout for danger signals:
- habitual slow payment
- broken payment promises
- unreturned calls
- postdated checks
And keep a close eye on accounts if you know the customer is about to change banks or refinance — this can be a symptom of cashflow problems.
When an account becomes overdue, take immediate action. Establish a debt collection routine and carry it out. Here’s a good process you can use to collect overdue debts:
1. Call Customers Whose Payments are Overdue
First off, find out the name of the person responsible for accounts payable. If that person isn’t available when you call, find out when is the best time to reach them.
Make sure you get the name of the person who takes the message (this is an excellent way to increase the chance that your message will actually get passed on!), and ask when the person you need to speak to will be available. If the person you need to speak to uses voicemail, leave a detailed, complete message and a clear request that he or she returns your call as soon as possible.
Create a sense of urgency, but be pleasant and courteous at all times. After all, there may be a problem you don’t know about — the customer may not have received your invoice, for example, which sometimes happens if the delivery address is different than the billing address. And if you enclose your invoice in the delivery package that goes to the delivery address, the billing address may never receive it! Or there may have been a problem with shipment. Either way, you’ll find out if you make the call.
If there’s no good reason why the account hasn’t been paid, get a commitment from the customer to pay you today. Expect payment and convey that expectation to your customer. After all, if you don’t believe the promise, neither will your customer.
2. The Check Is In The Mail
If you’re told the check is in the mail, ask for these details:
- when it was mailed
- the check number
- the amount
- the address it was mailed to
If the check hasn’t been mailed at all, you’ll know.
3. Don’t be Fobbed Off
If you believe you’re being fobbed off, it’s time to escalate things to the next level. Remain courteous and polite, but start pushing for a resolution. If the person you’re dealing with says they need to make enquiries and will get back to you, establish a time at which you can call back and follow through. Make sure the other person knows you’re not going to simply let the matter go. No-one likes to be hounded, so if it’s within their power, they’ll make sure you get paid (and off their back).
Other ways to push for a resolution are to make arrangements to send a courier to collect the check, agree on a new payment date, or even agree to their making payment in installments if you believe the problem is a genuine inability to pay (as opposed to mere unwillingness). If, however, you conclude that your customer has the ability to pay but, for whatever reason, is trying to avoid payment, don’t offer any compromises. That just sets the scene for a repetition in the future.
4. If All Else Fails…
In most cases, your persistence and firmness in your requests to be paid will result in exactly that. In a very few instances, however, despite your best efforts, a customer will simply not pay you.
Your response to non-payment in these circumstances will depend on your customer’s capacity to pay, and the amount of the debt. After all, there’s little point in hiring an expensive collection agency or a lawyer to recover a debt that your customer is simply unable to pay. Similarly, you have to weigh these costs against the value of the debt.
Sometimes the best business decision is to simply cut your losses and write the debt off. Naturally, you’ll never extend credit to this customer again.
If, however, the debt is significant and you have reason to believe that the customer is capable of paying, then by all means engage a collection agency or a lawyer to pursue the recovery of the debt. In these cases, be sure to include your recovery expenses in the amount that is to be recovered.
Lastly, don’t forget your supply terms. If these included a retention of title clause and the goods can be specifically identified as belonging to your shipment, by all means, repossess!