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Managing collections in an uncertain economy
March 16, 2010
The economic uncertainties facing many businesses today have put them in an odd position. Should they push customers harder for payments? Or go easy on them to avoid risking the loss of someone who had historically been a good client?
It’s a tricky balance and, interestingly enough, attaining it may have moreto do with you than your customers. Why? The better you know your own collection rate and the more you refine your collection practices, the greater your odds for success.
Calculate your collection rate
You may feel your collections are going badly but, until you put a number to what’s going on, you’ll likely find it difficult to fix anything. To better understand your collection rate, you must determine your business’s accounts receivable (AR) turnover ratio. Start by writing down your beginning and ending AR amounts for your last business year. Then add these two amounts and divide by two — this is your accounts receivable average (ARA). Finally, divide your annual net sales (noncash sales less returns and allowances) by your ARA to obtain your collection rate.
Clearly, this number alone won’t tell you much. You also need to compare it with that of other similar businesses. To do so, ask your CPA if he or she has any benchmarking reports for businesses like yours. And, if you belong to any trade associations, ask if they generate this type of information.
Along with knowing your collection rate, be sure you’re constantly aware of the status of your receivables in total, as well as how regularly each customer is paying you. Do this by frequent monitoring of AR aging schedules, with particular emphasis on amounts that are beyond normal payment terms.
Reassess your payment terms
What adjustments to your collection process should you consider? To get the brainstorming started, look at how customers pay you. What percentage of your payments come via check, credit card, bank debit and electronic funds transfer? Then examine your typical terms of payment by breaking this data into categories, such as per order; once per month payments from statements; and monthly, quarterly and annual prepayments.
The objective here is to align as many customers as possible to methods and terms that best fit your company. For instance, say roughly 25% of your customers make quarterly payments by check. That means your staff is spending a lot of time (and your money) generating quarterly statements and processing these paper-based payments. By converting these customers to annual prepayors (those who prepay annually) or automatic payors (those who pay automatically), you’ll get their money sooner and with less labor time.
Naturally, pulling off such a feat is easier said than done. Discounts or special pricing can help you make your case as to why customers should sign up for a prepayment plan. The nature of your work, however, may prevent this option. A product-oriented business, for example, usually can’t collect in advance of providing the product.
Create a collection plan
With your payment system realigned, it’s time to turn back to collections. Often, simply breaking down the collection process into a clear timeline can improve a company’s ability to cope with AR problems. Assuming your terms are net 30 days, you might break it into six stages:
- On or before the original due date,
- One day after due date,
- 30 days after due date,
- 60 days after due date,
- 70 days after due date, and
- Beyond 70 days.
At each of these stages, assign a specific action. For example, you might offer early or even on-time payment incentives to help customers make the first stage consistently. As you move down through the stages, increase the severity of your actions — from friendly reminders (e-mails, phone calls) to more strongly worded requests for payment. Keep a collection agency on the table but remember that using one will likely cause you to lose the customer and incur a fee.
Also bear in mind that, if you can’t collect on a debt, you generally can write off uncollectible outstanding debts as ordinary business expenses. Your deductible amount is limited to the amount of the uncollected, outstandingdebt that you’ve previously included in your gross income. You’ll need documentation of the customer’s promises to pay, your collection efforts and why the debt is now worthless.
In addition, if you use the cash method of accounting for tax purposes, you can’t deduct the debt because, under this method, income isn’t reported until payment has been received.
Show empathy, be strong
The difficult economy has put a strain on just about everyone. So it’s important to show some empathy to slow-paying customers. Still, even in more robust economies, only the strong survive, so do what’s necessary to ensure you get paid.
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