Many small businesses do a good job of delivering their goods and services, but then find it difficult to collect payment, often leading to a cash flow contraction. This may be because a customer’s creditworthiness was not properly investigated at first, or it may be that insufficient attention was paid to tracking and collecting bills owed. Either way, it is up to a business owner to establish reasonable credit policies, use proven techniques to optimize cash flow, and enforce terms diplomatically but firmly because “the sale is not complete until the money is in. Bank”.
1. Optimize cash sales to avoid risks
There is no credit risk in cash. If your business allows both cash payments and invoices, optimize the amount of cash, as a percentage of total sales, to the highest possible level for your industry or business sector.
2. Get deposits whenever possible
Larger sales orders, made-to-order products, and in particular custom orders, should require a deposit of 10-50% of the final purchase price at the time of order. This will go a long way toward alleviating cash flow shortages and also ensuring customer commitment to the order. Deposits of this nature must not be refundable.
3. Suggest credit cards for secure payment
Make sure you can accept all major credit cards (Visa, MasterCard, America Express, and Discover). This is the best alternative to cash and reduces the risk of payment. In many cases, it also makes a customer order easier. Customers who object to prepaying can be relieved by placing a “hold” on the sale amount against their card and processing the payment only after the product is shipped or the service is completed. This guarantees your payment (for a period, usually 30 days) but does not appear as a prepayment to the customer. For credit card sales that are processed, your credit card processing company credits your business account in 1-3 days for a 2-3.5% service fee.
4. Require progress payments for work-in-progress orders or contract sales
If you manufacture a product or perform work over a long period of time, say several months, include in your sales contract the specific hours that payments are due (for example: 10% at time of order, 40% at 60 days, balance at the end). This will go a long way towards avoiding liquidity problems and providing funds to continue the project. In many contract selling situations, the amount of the deposit is effectively the profit of the order and is obtained in advance; the balance or cost of the product is then transferred from the customer to the supplier on normal payment terms.
5. Develop and use a credit application form
Every business, large or small, engaged in invoiced sales must have a credit application. This can be as simple as a faxable one-page form that provides critical information such as the name and phone number of the customer’s accounts payable contact, department head, and CEO. The form must also require a minimum of two business references and a bank reference. A key administrative person (in smaller companies, this is usually the office manager) is delegated the responsibility of obtaining the information from the form, checking the references, and suggesting a credit limit based on the findings.
6. Set a credit limit for each customer, large or small
Once credit references have been verified, a credit limit must be established for each customer. For small customers, the credit limit should be set based on their demonstrated medium to maximum payment performance. For large companies, a credit limit should be established based on the amount of risk that your company is willing to accept and is a direct reflection of the percentage of your business that you are willing to dedicate to a customer. Normally, concentrating more than 10% of your business on one customer starts to be a risk; 30-50% is very risky and more than 50% is a potential disaster for your company. Bad things can also happen to big companies.
7. Monitor the aging of accounts receivable by total and by customer
At least weekly, calculate the average age of your outstanding invoices by customer and total. Assign responsibility (for example, Office Manager) for generating and reporting on this information. Develop an “Overdue” report that shows each invoice 5 days or more past its deadlines. Set specific and reasonable industry-based goals for “average days receivable” and link a component of your office manager’s compensation package to achieve the goal.
8. Develop standardized action procedures for overdue invoices
Develop a formal, written billing procedure that includes scripts or guidelines for communicating with customers who have outstanding past-due invoices. The approach taken is always courteous, but increasingly assertive as the delay time increases. Typically the first call is just a courtesy consultation. At 60 days they can be reminded of the company’s terms and if their credit is in jeopardy, at 90 days their account will revert to COD and at 100 days the litigation can continue unless payment is received immediately. If the last stage is reached, you must be prepared to move on promptly.
9. Avoid early claim letters and use the telephone
Claim letters, overdue notices, and statements indicating an overdue invoice generally do little more than irritate a responsible customer who may have a reasonable explanation for a slow payment. Instead, it is preferable that the person responsible for accounts receivable calls the person designated by the customer (found on the credit application) to ask if the invoice was lost or if there are any other problems. Typically 80% of slow payments are resolved this way and a relationship is created between key personnel from both companies.
10. Use discounted payment terms wisely, if at all
Offering a prepayment discount does not always produce the desired results. If your customer’s problem is cash flow, you won’t be able to take advantage of the discount. Often times, customers who already pay on time will benefit from the discount. You can properly rationalize this as a reward for good customers, but as a result, you’ve just reduced your overall profitability. Discounts that are attractive to customers often do not produce a favorable trade-off in the time value of money for your business. It’s best to survey your slow paying customers first, individually, to determine what the potential value of the discount could be for your cash flow.
11. Use your accounting system to help manage credit and accounts receivable.
Many small businesses use simplified accounting systems such as QuickBooks or Peachtree and these systems are capable of reducing the amount of time required for managing accounts receivable. Credit limits can be set by the customer and the system will provide a warning message when entering a new order in case said order causes the limit to be exceeded. Seniority reports by customer can be generated in a variety of formats. The data can be exported directly to an Excel spreadsheet and further analyzed if desired. Invoice data can also be exported directly to a customer by fax or email, saving considerable time. Current customer contacts and phone numbers are included in customer records and can be quickly extracted and used in on-screen reports to aid in collection calls. Be sure to use all the functions of your accounting system to assist you in your effort to manage credit and accounts receivable.