Many small businesses perform admirably when it comes to delivering goods and services but struggle when it comes to collecting payments, frequently resulting in a cash flow crunch. There was a failure to properly evaluate creditworthiness upfront or insufficient effort was put into monitoring and collecting past-due invoices. A business owner should set reasonable credit policies, use proven cash flow techniques, and enforce terms diplomatically but firmly, because “the sale doesn’t happen until the money is in the bank.”
If you want to avoid risk, make cash sales as efficient as possible.
Cash carries no credit risk. If your business accepts both cash and invoices, maximize cash as a percentage of total sales in your industry or commercial sector.
Collect Deposits Anywhere Possible
Larger sales orders, manufacture-to-order manufacturing, and, in particular, custom orders, should require a deposit of 10% to 50% of the total purchase price at the time of order. This will help alleviate cash flow constraints and ensure the customer’s commitment to the order. Such deposits should be non-refundable.
Suggest Credit Cards to Secure Payment
Ascertain that you are capable of accepting major credit cards (Visa, MasterCard, American Express, and Discover). This is the next best thing to cash in terms of payment security and reduces payment risk. In many cases, it also simplifies the ordering process for the customer. Customers who object to paying in advance may placate by placing a “hold” on the amount of the sale on their credit card and processing the payment only after the product or service is complete. This guarantees your payment (for a period of time, typically 30 days), but does not appear to the customer as an early payment. Typically, credit card processing companies credit your company’s account within 1-3 days following credit card processing for a 2–3.5 percent service fee.
Require Order Progress Payments
Include specific payment dates in your sales contract if you manufacture a product or perform work over an extended time, say several months (for example, 10% at the time of order, 40% at 60 days, and balance at completion). This will go a long way toward avoiding cash shortages and providing funds for the project’s continuation. Then, the customer pays the vendor the rest of the cost of the product under standard payment terms.
Design and Implement a Credit Application Form
Every business, large or small, that sells goods or services via invoice should have a credit application. This can be as simple as a one-page, faxable form that includes critical information about the customer’s accounts payable contact, department head, and chief executive. Additionally, the form should require at least two trade references and one bank reference. Typically, a key administrator (usually the office manager in smaller businesses) is responsible for obtaining information on the credit application form, verifying the references, and recommending a credit limit.
Set a credit limit for each customer, regardless of size.
After checking credit references, each customer should have a credit limit established. Credit limits for small customers should be set based on their demonstrated payment performance from mid-level to the maximum. For large businesses, a credit limit should establish based on the level of risk that the business is willing to take and be a direct reflection of the percentage of business that the business is willing to devote to a single customer. Concentrating more than 10% of your business on a single customer consider risky; 30%–50% consider extremely risky, and more than 50% consider a recipe for disaster for your business. Even large corporations can suffer setbacks.
Keep track of the aging of receivables by total and by customer.
Calculate the average age of your outstanding invoices by customer and total on a weekly basis. Assign responsibility for the generation and reporting of this information to someone (for example, the Office Manager). Create an “Overdue” report that lists all invoices that are five days or more past due. Establish specific, reasonable goals for “average days receivables” based on your industry and tie one component of your office manager’s compensation package to meeting the goal.
Establish standard operating procedures for dealing with past-due invoices.
Create a formal, written collection procedure, complete with scripts or guidelines for contacting customers who owe you money for past-due invoices. The approach is always courteous but becomes increasingly firm as the amount of time past due increases. Typically, the initial call is a polite inquiry. At 60 days, they may remind of the company’s terms and their credit may be jeopardized; at 90 days, their account may revert to cash on delivery; and at 100 days, litigation may commence unless immediate payment is received.
Avoid Dunning Letters in the Initial Stages
Dunning letters, overdue notices, and account statements indicating an overdue invoice usually serve only to irritate a responsible customer who may have a legitimate reason for late payment. Rather than that, it is preferable to have your accounts receivable (AR) representative call the customer’s designated accounts payable representative (found on the credit application) to inquire whether the invoice is misplacing or if there is another issue. Typically, this method solves about 80% of late payments and builds trust between the people who work for both companies.
Select Discount Payment Terms Carefully
Offering a discount for early payment does not always yield the desired results. If your customer’s issue is cash flow, he or she will be unable to take advantage of the discount. Frequently, customers who are already on time with their payments will take advantage of the discount. You may legitimately justify this as a reward for loyal customers, but you’ve just reduced your overall profitability. Discounts that are attractive to customers frequently do not result in a favorable time value of money offset for your business. To figure out how much discounting could help your cash flow, you should first talk to your slow-paying customers one-on-one.
Use your accounting system to help with credit and receivable management.
Numerous small businesses utilize simplified accounting systems, which are capable of reducing the amount of time required to manage accounts receivable. Credit limits can be set by the customer, and the system will display a warning message upon entering a new order if the limit is exceeding. There are several ways to generate customer aging reports. It is possible to export the data directly into an Excel spreadsheet for further analysis. The invoice data can also send directly to a customer via fax or email, saving considerable time. Dispatch screen reports can easily extract customer contact and telephone numbers from customer records. This helps with collections calls. Make sure that you are taking advantage of all of your accounting system’s features to help you manage credit and accounts receivable (AR).
Having reasonable credit policies, using proven cash flow management techniques, and enforcing terms politely but firmly is in the best interest of a business owner. This secures business owners’ interests and helps them grow their business effortlessly.