When you win a contact or snag a purchase order, you are merely creating a contractual obligation between two parties -- there is no guarantee that the contract will be successfully concluded--that is, with money in you bank account.
Often, without a sound collection system in place, the small business owner realizes too late that the money promised won't be paid. Her option then is either to take legal action, which smart entrepreneurs try to avoid, or accept a loss, which can drive your company into a serious cash shortage.
The key to successful financial control of your business is to install dependable techniques for regulating the flow of cash into and out of your business. The goal: Achieving "positive cash flow, " which simply means having more cash coming in regularly than going out.
As we pointed out in last month's column, a business can seem quite profitable on paper but still run chronically short of cash. This often results from either ill considered granting of credit or poor collection of money owed.
Credit Policy--As Supplier and Customer
To examine how you wish to control your credit sales, you should ask and answer a series of questions:
You are obviously walking a tightrope with your credit policies --too tight and you lose customers; too loose and you lose money.
Even with a written credit policy, three are additional steps you should consider to protect yourself when you sell, particularly to first-time customers.
When you accept checks, make sure the check is made out properly. In particular, make sure that it is signed and includes a pre-printed address and local phone number. Ask for and record the driver's license number. If the check is unusually large, consider calling the check writer's bank to verify that they have the account open.
If you are in a retail business, clearly post near the cash register the time limit on making returns. This tends to cut down on stopped payments. If you are selling by mail, hold the shipment until the check clears. If you accept large amounts by check to take in many checks, consider using an electronic check verification system, such as TeleCheck.
Before extending credit or delayed payment, establish your payment terms in plain English, clearly visible to the customer, perhaps at the bottom of your receipt or invoice form.
Have candidates for delayed payment fill out a simple credit application that includes their company (or personal) name, address, phone and fax numbers, your customer's name and title, how long the company has been in business, the customer's business bank with bank address and contact person, bank account number and two or three supplier references.
Check their credit references by calling and asking the reference how long they have done business with this customer, the largest amount this customer has owed them in the last year and how many days they took to pay invoices during the past three months. (You will not usually get any more information than this from a reference.)
If you are dealing with a consumer, ask whether they own or rent, how long they have lived at their current address (if less than two years, ask for the next previous address), where they work (be sure to call to verify employment) and their family bank account number.
Some industries have their own credit rating agencies. Ask around.
Sales Contracts and Promissory Notes
Promissory notes are simple, easy-to-do alternatives to verbal agreements when issuing credit. They are customarily used only with purchases where the credit is extended for more than one month. You can buy blank note forms at an office supply store and then type in the following information: the borrower's name, the amount being borrowed, any deposit paid, the schedule of payments, the percentage of interest being charged and whether the note can be extended.
You may wish to add the penalty for late payments, the right to demand full payment if payments are not made on schedule, and a clause specifying that the borrower must pay legal costs to collect the debt from them.
Key points to be included in a sales contract include a description of the loan being made, the amount of payment expected and when it is due, the length of time the agreement will last and whether it may be extended, under what circumstances the contract may be terminated and by whom, how the customer may lodge a complaint about the product or service and what recourse you have if your customer does not pay. Consult an experienced small business attorney to insure that the contract says what you mean.
Collecting Your Money
Once you have set your policies for granting credit and accepting checks and credit card payments, you should focus on creating a reliable system for tracking what money is owed to your company and then systematically Collecting the money.
To effectively collect money, keep several principles in mind:
As you prepare to start your first order with a new customer, ask them to specifically detail for you what procedure you must follow when submitting bills to them. Included may be: how many copies of the invoice must be sent and to whom; must proof of shipment or project completion accompany the invoice; are there certain dates each month for submitting invoices; if there was a problem with the job, whom do you call to settle the problem.
Setting Up Your Collection System
The key to successful collection of money is to design a series of steps and implement them on a disciplined schedule. There are four stages you should go through in trying to collecting money owned to your company:
#1 - Notification or polite reminder stage
#2 - Formal appeals or discussion stage
#3 - The push or firm demand stage
#4 - The "Squeeze" or "bitter end" stage
Notification Stage
Common techniques at this stage include mailing and faxing a second copy of your invoice; sending a statement stamped "past due" and sending a revised bill showing a penalty if it isn't paid by a specified date.
Formal Appeals Stage
You've mailed to the customer and called them. They acknowledge the debt but still haven't paid and are vague about when they will. At this point, you must turn up the heat. Try a series of reminders, fourteen days apart--perhaps two. If you aren't paid after the second notice, chances are that your customer either finds a problem with what you sold; or they are having financial trouble, which they don't want to discuss with you.
It is good at this stage to give your customer/debtor a way out of an embarrassing situation. An example of how to do this is contained in the letter below:
Dear Mr. Jones:
We know that you are very busy and that's probably why you have forgotten to pay our invoice of May 1, 1995 in the amount of $500.
To make it easier for you to take care of this, we've enclosed self-addressed envelope. Won't you please send in your check today, so we can keep your account up to date?
Sincerely.
Firm Demand Stage
By this point you should have determined which situation your customer is in:
(a) acknowledges your debt, but claims he doesn't have the money to pay; (b) honestly disputes the debt and won't pay until the dispute is resolved;(c) doesn't want to pay and probably never will. The third situation is often the hardest to detect.
Deadbeats are very good at disguising their behavior until after you sell to them. The first variation-the customer wants to pay but can't can often be worked out with a fair repayment schedule and regular reminders.
The second variation should not happen often if you give good customer service. You should know about disputes before you send the invoice.
The third variation is a tough nut to crack. This type of customer is basically stealing your money, but knows that without going to court you will have a hard time proving it. They weren't loyal to you from the beginning so they don't really care if you cut them off. These types are often described as "customers from hell". Occasionally, a collection agency can squeeze some money out of them. But it is best to try to avoid them in the first place, by checking their credit carefully, using your eyes to look around when you visit their facility and letting your intuition work.
7'he Squeeze Stage Once you feel compelled to make your final demand, it is hard to go back because this is serious business at this point. Your best hope often is to motivate the debtor to make a counter-offer to what you are demanding.
Commonly used steps detailed in your letter include:
What do you do if this doesn't produce payment? Well, your options are somewhat limited if you don't want to engage in physical threats, which we don't endorse. If you decide to legal action, this final letter is important to show the court that you have taken reasonable steps to allow your creditor time to pay-
Tip: One of our students used a somewhat novel technique to collect on a bad out-of-state check. He called the town sheriff (found in directory information) and explained who he was and that he was a small business owner who could not afford to lose this money. The sheriff knew the individual who wrote the check and went to visit her. Money was forthcoming shortly after his visit!
Final Outlook
To avoid as many money collection problems as possible, start by clearly stating what your payment terms are. Negotiate them if necessary, but make sure they are crystal clear before you expend one hour of labor.
Make sure you invoice quickly upon completion and follow-up dependably within days of the payment due date.
If no payment is received, use a series of increasingly serious letters and phone calls to prompt action. Don't threaten anything you aren't prepared to do.
Be willing to get something rather than nothing from the worst creditors (hopefully you will avoid them in the first place).
About the Author
Jeff Williams worked for big business for years, until he decided to take his career in his own hands by establishing his practice as a business coach. Now Jeff offers you the information he had to learn the hard way -- and he shares it with you in his Ultimate Boomer Business Start-Up Guide.