Our last couple of newsletters have looked at big picture issues. Our first issue for 2021 looks at a detailed issue. It may be that you're enjoying a brief break from the tyranny of your business, but all the while some clients are doing the same - but on your money. The sale might have been made, but the sales over until the cash is not in your account. We suggested some things to improve this in July, but as usual, there's so much more than we can cover in one article. Even this has been truncated - there's more detail in each of the steps.

The impact of not managing debtors

Before we look at strategies for accomplishing this, let’s think about how payment time affects your business. Invoices represent money that is yours, not the customer’s. What would it mean to your business if you had that money on hand and you could use it for purposes such as investing in your business or paying the next instalment on that asset you just purchased?

Money outstanding is your money that you could be using profitably. Carrying too much in the way of debtors can endanger your cash flow and your business's survival. It absolutely needs to be managed.

Prevent problems – follow the rules

Let’s look at some straightforward rules (they're your rules - you're the one who loses when you don't follow them) you could be operating by to prevent debtors from blowing out in amount, and in the time they remain outstanding. Then we’ll look at a structured way of dealing with those customers who don’t pay within the credit terms you offer.

  1. Develop a credit policy
  2. Send out invoices promptly
  3. Be systematic about tracking debtors
  4. Measure the key performance indicators
  5. Take action on accounts immediately they go past the due date
  6. Build good payment habits among your customers

Develop a credit policy

First, make sure that customers clearly understand payment terms when you make a sale – this is Rule 1. If appropriate, put them in writing. Many small businesses are reluctant to establish a firm credit policy for fear of losing customers but what they don’t realise is that a consistent credit policy not only protects the company but also creates a more professional image with customers. A written policy can have some very good side consequences as well, such as:

  • Providing consistent guidelines to the team as to when they should allow credit
  • Demonstrating to both the customer and your team the seriousness of managing credit.

Get invoices out promptly

Rule 2 - send out your invoices promptly. Make your invoices clear and businesslike, including all relevant information – not just on the sale item such as price, product description, date of sale and product or service codes, but particularly the date by which you expect payment. Don’t give customers the opening to make their own assumptions about when to pay, as those assumptions will generally be generous – to themselves.

Clearly stating these details will minimise the risk of disputes and delaying tactics based on apparent ‘misunderstandings’. Being clear in including these details will also improve your chances of winning legal proceedings and winning quickly, should the worst occur.

You can even go further by stating the interest rate and terms under which interest will accrue.

Track Your Debtors Systematically

Rule 3 - be systematic about tracking debtors. You might want to use a software package so that you have daily access to information on debts. All product and customer details should be immediately accessible when you look at a particular debt.

There is a particular report you should have produced each month, whether manually or by your software – the Aged Debtors Trial Balance. It can be very useful in identifying potential cash flow problems and emerging problem debtors.

You could use it also to make decisions on which customers you might increase the credit limit towards and those you might rein in – after all, credit terms you offer to a particular customer should change over time as circumstances change. If a customer starts to lag badly in their payments you would be entitled to change the credit terms you offer them until they improve.

Key Performance Indicators For Debtors

While we’re talking about tracking, let’s look at two key performance indicators for debtors. Firstly, you can calculate the average number of days of your debtors - that is, the average time it takes debtors to pay you.  In effect, it is an indicator of how effective your company is at collecting payments.

You can then ask yourself two questions:

  1. Is this OK for the industry I’m in? There are industry benchmarks for debtor days and you ought to check how you stand. If you’re waiting a lot longer than average then maybe you should be looking at why.
  2. What would be the effect if I could shorten this by a week, or two weeks, or whatever - how much extra money would I have on hand at any particular time?

You may already know what your debtor days figure is. If not, we can show you how to calculate it. Reducing debtor days can make a dramatic difference to your cash flow.

The second KPI for debtors is your ratio of bad debts to accounts paid. If you find that more than two or three per cent of your debts go bad, you need to take this as a trigger for some decisive action.

So Rule 4 – measure the KPIs.

It’s Gone Overdue – Now What?

Rule 5 - take action on accounts immediately after they go past the due date. Start with polite reminder notes, escalating to a phone call or a visit if the account is not settled.

Be polite, persistent and professional when making contact with debtors. While you want to be firm, you don’t want to be perceived as harassing people. You also want to leave yourself the option of continuing to do business with the debtor, so you don’t want to alienate them. However, with seriously overdue accounts, you may be better off suspending further supplies until the debt is paid.

Create a collection process (why do you think people pay debt collectors?), develop a collection schedule, find the right tone (maintain the relationship while conveying serious concern), politely press for payment, and solve any problems immediately. Should a second call be necessary, maintain rapport but be assertive. Get another commitment, including a date.

As a final resort, have a lawyer send a letter, go to small claims court or use a collection agency. Don't forget to note the details on the client's record in your system - memories fade (especially if there are multiple people involved).

Build Good Payment Habits

Those are worst-case scenarios. There is something you can start doing right away though to reduce the likelihood of things going so far.  Follow Rule 6 - build good payment habits with your customers.

First, set out the terms so everyone knows the rules and has something to aim for – for instance: ‘Our company has a strict credit policy, and credit lines will be extended only to the most credit-worthy accounts. New customers who fail to meet our credit criteria will need to purchase using cash-on-delivery terms until they establish their ability and willingness to pay on our terms.

Secondly, if you are offering a discount for early payment, make sure it is PROMINENTLY displayed on the invoice to catch attention. You are working with human psychology here, and the offer of a discount just might get the invoice attended to fast.