Does Your Collections System Need a Checkup?
If your accounts receivables are threatening the health of your business, it could be time for a system overhaul.
You know how important preventative maintenance is for your health. You see your doctor for regular physicals and go for check-ups with your dentist. You most likely bring your car in for tune-ups, too. But what about your business? A dose of preventative maintenance can go a long way toward keeping your company in good health.
One area that can usually use some TLC is your overdue receivables. Overdue accounts can cause havoc with company cash flow. If your receivables are giving you headaches, a review of your systems may help you find ways to fix your collection problems.
For example, let's say Jack is a human resources consultant and has a staff of five and a solid roster of business clients. But he regularly finds it difficult to make his weekly payroll. Sound familiar? A quick review of Jack's financial statements is encouraging, until we find that Jack is carrying close to $100,000 in accounts receivable, half of which are more than 90 days overdue. This presents a challenge because Jack can't write checks off unpaid receivables!
Can you identify with Jack's experiences? Are you in the middle of a cash crunch? Cash flow problems happen for one very basic reason-customers don't pay in a timely manner. But the real issue you have to address is the underlying cause of these late payments. Why aren't your customers paying on time? If you can discover the primary reason and make needed changes, you can usually turn the problem around.
There are generally two reasons customers don't pay their bills on time. Either they're not happy with the product or service they've received or they've got their own financial problems. Recognizing this, you can take steps to minimize your collection problems.
The Unhappy Client or Customer
When it comes to paying what they owe, "The happy customer pays quickly; the unhappy customer pays late (if at all)." So one way of improving your collections is to make sure your customers are satisfied. Here are a few ways to do that:
- Use a written contract with your customers. By clearly spelling out in writing what products and services you're providing and your payment terms, you'll help avoid misunderstandings.
- Keep your customers well informed when it comes to their orders. If there's a delay or some other problem, let them know how you plan to deal with it.
- If a problem does arise, remember that "The customer is always right." In other words, you can't win by arguing with an unhappy customer. Therefore, it's in your best interest to find a way to turn him or her into a happy customer. It's definitely a challenge, and one we've all faced, but if you're successful, think of the impact. How many people do you think your now-happy customer will tell about your first-rate customer service?
The Financially-Challenged Customer
What about the customer who's not paying you because of financial problems? Once you're in this situation, it's usually too late to take any meaningful action. But let's look at ways to improve your intake system to help avoid this problem in the future:
- Get your payment upfront. It's certainly the most effective way to avoid collection problems. Clearly, however, you have to be consistent with the standard practices in your industry. There are some businesses that may not be able to get up-front money from their customers. For other businesses, however, this should be standard operating procedure. As a consultant, for instance, Jack should be requesting a 50-percent retainer upfront before beginning work on a project.
The upfront retainer fulfills several important functions. First, it shows that your customer is committed to the project-it's a sobering decision point when they have to write you a retainer check. If he or she is not willing to show that commitment, it's good to find that out before you start doing any work for them. Second, it proves that your client has the financial ability to pay your bill. Lastly, it cuts down on the time you'll need to spend chasing receivables.
- Be careful who you lend to. While you may not think of yourself as a bank making loans, if you're supplying goods or services on credit, then in effect, you're acting like a bank to your customers. Would a bank agree to a loan without checking a customer's creditworthiness? Of course not. And neither should you. So have your credit customers complete a credit application and review it carefully. Be sure to check those credit references and find out if their payment history is good.
- If your customer is a small business that's incorporated, have the owner personally guarantee the obligation. Otherwise, you'll be limited to the assets of the business entity while the owner's personal assets are secure. There's another benefit to getting a personal guarantee from your customer: If he's got cash flow problems and has to choose which supplier to pay, wouldn't you want your invoice to go to the top of the pile? It's more likely to do so if the business owner's personal assets are on the line.
- Make sure your contract protects you. If you end up suing a customer to recover what you're owed, you'll want to be able to collect interest, attorneys' fees and other collection costs. Unless your contract provides for that, however, you're not legally entitled to recover those expenses.
It will take a little time to review your accounts receivable systems, but it's time well invested. By getting your systems in order, you'll improve the health of your business and save yourself major headaches down the road.
Judy Gedge is a West Hartford, Connecticut-based lawyer specializing in small-business law. She's also the author of A Legal Road Map for Consultants. She can be reached at firstname.lastname@example.org or www.gedgelaw.com.