The extension of ‘credit’ is often very lax in the startup phase of a business, and usually, no written policy exists. Past due accounts receivable is often a result of not clearly defining the customer’s expectation, granting credit to customers without consistent criteria, and a lack of disciplined follow-up ofaccounts receivable by the business. Businesses with significant past due balances have ‘trained’ their customers to expect a lax or non-existent collections effort.
These outstanding receivables are costing the business money. The business has already expended time, resources, and cash on providing the product or service to the customer. No matter what type of accounting is used, Cash or Accrual, the business has not received payment, and therefore ‘cash.’ Consider past due balances as a ‘gift’ to the customer until paid. Once a business owner recognizes that they are giving away their hard-earned business, they are more likely to pay attention to past due to AR.
Start By Reviewing The Balance Sheet and Accounts Receivables Aging Reports.
Look for ‘past due’ account balances and aging. Determine the percentage of aging based on total AR or Sales. If there is a significant amount of ‘past due’ AR, it is likely that much of it has been ignored due to infrequent reporting or not wanting to ‘aggravate’ existing customers by requesting payment, or perhaps no policy is in place to define credit terms or collections policies. The first step to resolving large past due balances is to STOP extending credit without clear criteria, customer vetting, and adherence to a written policy at every level.
The next step in the process is to analyze past due credit balances, starting with the most significant balances. First, make sure all customer credits have been applied to the appropriate invoices. This is referred to as ‘housekeeping’ tasks. Most successful past-due collection efforts start with the 61–90-day balances. If the client has a great deal of over 90-day balances, much of this debt will be difficult to collect and may need to be ‘written off’ as a Bad Debt expense. Bad Debt expense goes directly against Net Profits and is contrary to achieving long-term wealth and retained earnings.
Establish a Collections Approach
The recommended past due balance collection approach is to start with a phone call. Phone calls are more personal and offer an opportunity to connect with and understand your customer. If you must leave a message, identify yourself, state the reason you are calling, include pertinent invoice information, and request an action such as ‘Please call to resolve past due balance today.’ Sometimes, this process discovers something as simple as an invoice that was lost or misplaced. These situations are easily remedied, result in payment, and often establish greater customer loyalty for understanding and resolving the issue. During the initial phone call, it is always important to establish that there was no problem or issue with the product or service.
Always attempt to get payment over the phone if possible. It is also best to give the customer a couple of discrete options such as ‘pay half today, and the balance in XX Days’ instead of asking open-ended questions like ‘when can you pay the past due balance?’
A detailed log of collection activity and conversations is essential to reducing past due balances. This log is helpful as the process progresses and signals to the customer that you are serious about collecting past due balances. Immediate follow-up to confirm the phone conversation is another key success factor in managing past due balances. An email or letter sent immediately after briefly recapping the conversation and commitments may help reinforce the collection action. These written follow-ups also are referred to in potential future discussions if obligations are not kept. Make sure to identify to whom you are speaking in notes and follow-up correspondence. Often you need to escalate who you need to talk to if past due balances continue to be unresolved. If a customer gives an excuse that they need someone else to do something, then contact that ‘someone else.’
Establish Solid Policies and Stick To Them
Good AR practice starts with a solid credit policy and approval process. STOP the extension of credit without a proper credit approval process immediately. If a Credit Application exists, does it gather pertinent information on the potential account? This should be tailored to the business and consider the conditions that led to existing past due balances and seek information to qualify accordingly. This vetting process is critical to keeping accounts current, and bad debt write-offs to a minimum. If you require a customer to provide banking or credit reference information, follow up to make sure it is accurate and a good credit risk. This step is often skipped but has everything to do with a customer’s creditworthiness. The process of filling out a credit application causes the customer to evaluate their situation and potentially discourages them from seeking to obtain credit currently. By requiring business information, including billing contacts, business longevity, and references, the result of collecting AR balances improves dramatically. Several independent agencies such as Dunn and Bradstreet exist for evaluating creditworthiness and should be used where appropriate. Another good technique is to require that a customer establish good credit by paying for products or services for several transactions before considering extending credit.
Define and implement an AR and Credit policy with buy-in from Owners, financial managers, and sales personnel. Start with a good template and tailor it to the business.
Buy-in from every part of the organization is essential, involving others in the development and implementation process. The credit portion of the policy should establish the vetting process, which makes the final decision, and establishing the ‘credit limit’ extended to each customer.
The AR policy should establish the steps the company will take in monitoring and collecting past due accounts.
Look Within Your Own Business
Often a business owner is quick to judge its debtors harshly, and yet has aging Accounts Payable as well. An assessment of the total AR and AP encourages a complete picture of the business’s cash position, and highlights the need to reduce AR and AP. The old adage of ‘treat others how you would expect to be treated’ goes a long way. Regular review of AR aging reports, along with clear AR and Credit policies, keeps past-due account balances low and bad debt to a minimum.
Utilizing tools such as a cash management system, cash conversion cycle calculations, AR-AP worksheets, and working capital metrics, you will establish good processes and measures to achieve a good cash flow position and minimize bad debt expense. By proactively managing and measuring your cash flow accordingly, you will be able to maximize wealth generation and increase retained earnings.