Six Steps To Avoid Bad Debts

How well you do your debt collection can make or break your business. Every business has different methods and issues, so let's look at some of the key factors in running a successful debt collection process, in a typical business.

By typical business, I mean one that offers credit terms to its customers and sends out invoices.

Here are the six steps:

1. The when and how of sending invoices
2. Giving customers options to pay
3. Terms of (business) trade and credit
4. Statements/reminders - why every week if necessary!
5. Debt collection/recovery
6. A small investment in debt management

1. The when and how of sending invoices
   
   When you do your invoices can have a huge impact on your cash position. You may be staggered to hear that one business owner advised me he sends out his invoices when he runs out of money! This is not untypical of many small businesses who struggle to manage the paperwork. It's easy to get sidetracked with sales, marketing and delivering a product or service and fail to collect payment. This is probably the single biggest culprit in business failure. 
   
   If you don't keep the working capital coming in, you quickly struggle to run other aspects of the business, like paying suppliers and your staff etc. If you can get a systematic programme for invoicing, you are well on the way to good financial management. The sooner you can invoice your customers, the less money you need to find from elsewhere, such as bank loans or equity loans to cover running costs.
   
   How you do your invoicing is as important as when
   
   If it's hand written or on scrappy stained paper, it is likely to be treated casually by customers. If it looks professional and contains all the required details, it is more likely to be treated seriously. One of the most important details to be contained on any invoice is the Credit Terms i.e. how many days the customer has to pay the invoice.
   
   You would be amazed how many businesses omit this from their invoices, even some very high profile organisations who should know better! The problem with not detailing credit terms is that customers will make up their own! They will decide to pay you when they feel like it, or when they can. Other suppliers, who have put credit terms on their invoices, are likely to get paid before you. So give yourself a head start by putting terms on your invoices.
   
   
2. Giving customers options to pay
   
   Giving your customers as many methods of payment as possible, is a sure fire way of increasing the speed and your chance of getting paid. Not all customers work the same way. Some people still like to write cheques, some like to pay by internet banking, some like to pay by credit card. 
   
   Credit card merchant fees can be expensive, but not as expensive as waiting 60 or 90 days for someone to get round to writing a cheque. We live in an age where there are so many methods of payment available, so why not utilise them all to ensure you get paid, one way or another.
   
   
3. Terms of (business) trade and credit
   
   It's interesting how many businesses get excited about their product or service and completely forget about the importance of getting paid. Getting paid is the first thing you should think about in any business. This means you need to ensure your customers understand how much, when and how they should pay you.
   
   The best way to achieve this is to have a simple ‘Terms of Trade' or ‘Terms of Business' document. This can be given to the customer when you are going through the sales process or emailed at any time. That way there can be no excuses for non or late payment.
   
   A good ‘Terms of Trade' document should also contain a clause about ownership of any goods until they are paid for. Such a clause can save a business from financial ruin where a big customer goes into liquidation holding onto unpaid stock. If you have an ownership clause, you may have the right to retrieve goods unpaid for.
   
   Credit Checks are a really good way to deal with potential bad debtors. If a customer can't give you at least three credit references, perhaps you may be better off avoiding them. No sale could be better than a bad debt, as you don't incur the cost of delivering the goods or services as well as the loss of payment.
   
   The quick and easy way to see who owes what
   
   Once you have sent out invoices and they have terms on them, it doesn't automatically follow that customers will do the ‘right thing' and pay on time. You need to be able to easily monitor what is owed to you, by whom and for how long. 
   
   A very simple report that you can get from accounting software, lists all those customers who owe you money, how much they owe and how long they have owed the money. This gives you a very quick and easy way to see where you should be concentrating your debt collection efforts. 
   
   The more often you can look at such a report, the better your cash position will be, if you use this report as a basis for your debt collection.
   
   
4. Statements/reminders - why every week if necessary!
   
   As mentioned above, sending out invoices and letting customers know the terms, doesn't guarantee you will get paid on time. You need to let customers know you are serious about getting paid. The best way to do this is to send out regular statements. 
   
   Statements not only remind customers it's time to pay, but let them know you are ‘on top' of the situation in relation to outstanding debts. If unscrupulous debtors get the impression you aren't organised about debt collection they can take advantage of the situation. 
   
   Put yourself in a debtor's shoes or the shoes of their Accounts Payable person. They get all kinds of invoices coming via mail and email. Which ones are they going to pay first? Those who seem disorganised with shoddy practices, or those who appear professional and serious about debt collection. 
   
   All good accounting software has the ability to produce statements. You can send them whichever way you prefer; be it mail or email. You can be sure though that the suppliers who remind customers about payment are going to get paid ahead of those who don't.
   
   
5. Debt collection/recovery
   
   It's interesting how many business owners write off perfectly recoverable debts. For some reason they feel it's not worth the effort to employ a debt collection/recovery agency to collect the debt for them. If you have exhausted all efforts to get paid by a customer, I can highly recommend employing the services of a good debt collection agency.
   
   At this stage you may not want to do any more business with the customer so getting tough should not be a problem. Any good debt collection agency though, should perform their task without you having to lose a customer. Some use poor tactics that can sour the relationship, but there are good ones around who understand the importance of maintaining good customer relations. You should not hesitate to employ a debt collection agency, as you should have the right to charge your customers the costs, if you have included this in your ‘Terms of Trade'.
   
   
6. A small investment in debt management...
   
   ... can save you heaps later! All of the above will happen if one person is allocated the responsibility for Debt Management. They may not have to perform all of the tasks, but if one person is responsible to oversee the process, it's more likely to get done properly. It may seem like a large expense but the cost of not managing debt collection can be very high, in terms of lost working capital and accumulating bad debts.

Read the article "How To Speed Up Payment From Customers" 

Sue Hirst, Director, CAD Partners (CFO On Call). CAD Partners is a team of Financial Controllers who can review your accounting systems, advise on how you can improve your cash position and profitability. Please feel free to call us on 1300 36 24 36 or visit the website: www.cadpartners.biz. Mention this article to receive a FREE Financial Health Check. There is also a FREE e-book on Cashflow control available to readers of this publication. To see further details of this e-book go to http://www.cadpartners.biz/e-book.htm
First published: 24 May 2007.
Last updated: 24 May 2007.