Prompt collection protects your bottom line

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Making a sale: Great! Collecting past-due accounts: Lousy.

Late-paying customers are always a problem. In a slowing economy, though, burgeoning accounts receivable can do serious harm. Worse, uncollected bills can create a real cash squeeze.

"The risk of extending credit is not just about not getting paid," says Robert S. Bernstein, a partner in the Pittsburgh-based Bernstein Law Firm and author of Get P.A.I.D. "There's also a real cost of getting paid late."

Costs Of Credit

Payment delays cost you money for a number of reasons, according to Bernstein. First is the finance cost: When you extend credit you are really making a no-interest loan to your customer. So you really lose money at the level of current interest rates for the time a customer delays payment.

Bernstein gives this example of finance cost: Suppose your business can borrow money at 12 percent a year. When you lend a customer $1,000 for 30 days, the extension costs you 1 percent, or $10. If your customer pays six months late, extending the loan for that period has cost you $60.

Second, your business incurs an opportunity cost when a customer pays late. What profitable use could you make with money that's tied up in your customer's account?

Third, there's the cost of collections: That's the time and labor you spend telephoning, sending dunning notices, and so on.

Finally, don't overlook what Bernstein calls the "relationship cost" of late payments: Try as you might to issue friendly reminders to a late-paying client, it's beyond doubt that your customer is going to hesitate to do business with you again.

Profit Or Loss?

Putting a dollar value on many of these costs can be difficult, notes Bernstein. But it's a sure bet that they add up to a profit-busting problem. "Whatever the precise values of these costs, the longer the customer goes without paying, the more they accrue."

Even an increase in overall cost of 2 percent a month can eat into a business's profit margin, notes Bernstein. Indeed, it's possible for profit to disappear. Suppose a business's collection costs come to 3 percent a month. In six months that will total 18 percent. If the organization's operating profit is 20 percent, its profit is pretty much gone.

Bernstein gives another example: "Suppose all of the costs associated with collecting come to 5 percent of a sale. If your usual profit margin is 2 percent you would have been better off writing your customer a check in the beginning, rather than making the sale."

It's worse, of course, to not get paid at all. "If your cost of a sale is 80 percent, then that is your risk," says Bernstein. "If you make a $10,000 sale where the cost and overhead is $8,000, and you never get paid, it's like you flushed $8,000 down the toilet."

Collect Vigorously

What can you do to protect yourself? Rule No. 1: Establish a rigid payment policy and stick to it. "The biggest mistake that I see is the lack of a very consistent collections system that is religiously followed," says Donald Todrin, principal of Todrin and Associates, a management-consulting firm in Amherst, Mass.

"Customers have a tremendous ability to figure out who needs to get paid quickly and who doesn't," notes Todrin. "They are very aware of the collections practices of the people with whom they do business. Are your invoices not being sent out on time? That's a clue that you are lax. Your bills will be put on the bottom of the pile and you'll be paid after the guy who keeps to a set of rules."

Here are some tips from Todrin:

Bill promptly. "Generate an invoice as soon as possible," says Todrin. "Most businesses start counting net 30 from the day they receive an invoice. So you want to get it out the door as soon as possible. If you wait a week to generate an invoice, that shows weakness and a lack of control."

Act quickly when payments are late. "If an invoice is net 30, make a friendly service call," suggests Todrin. "Sometimes you can disguise a credit call with a service orientation. Say something like this: 'I notice you have a payable due this week. Is the invoice OK?' In this way you are getting in front of the ball, solving problems before payments are late. Maybe the invoice has gotten lost. In which case, offer to fax them the form they need."

If payment is late, solicit a promise or an agreement to pay by a certain date, says Todrin. Ask, "When can you schedule this invoice to be paid?" and solicit a reply such as, "I will send it out Friday." Then call Friday and ask, "Was it sent? Thank you and I appreciate it." This approach rewards everyone for performance, notes Todrin. "Stay on top of the problem with cordial calls."

Assign a dedicated collections person. "The individual must see collecting as a high priority and must vigorously pursue accounts," says Todrin. Salespeople aren't the best choices: Their desire to close future deals creates a conflict of interest.

A system with the above elements communicates your commitment to collecting promptly. Proceed nicely but firmly, advises Todrin. "The trick is to follow your terms and demonstrate you will not allow customers to get sloppy on their end."

Vet New Customers

A rigorous collections system can keep accounts receivable under control. However, additional steps need to be taken when you take on new customers. You need to ask yourself: What is the likelihood that bills will be paid? And how can I increase the odds of a good experience?

"In this economy you have to be very careful that you are not just generating business to increase volume," says Frederick W. Alworth, a director in the business and commercial litigation department in the Newark, N.J., law firm Gibbons. "We see a lot of instances where businesses undergoing slow periods are agreeing to sales they would ordinarily turn down. For a new client it is critical to get more information than you would have obtained in the past."

How can you vet a new customer? Here are some tips from Alworth, who notes his comments are only applicable to collections from other businesses. Collecting from consumers is trickier. "Debts for consumer purposes must be treated differently from that of business debtors," he says. "There is a minefield of legislation on both the federal and state level that protects consumers." (See sidebar, "Collecting from Consumers.")

When checking out a business, says Alworth, step No. 1 is usually pulling a detailed Dun & Bradstreet report. These give you credit and payment scores. And if they have been recently updated they might inform you whether the assets of a business are subject to a security agreement. "Maybe the company has pledged all its assets to a bank so if you get a judgment you will be in line behind a secured creditor," says Alworth.

Unfortunately, you cannot completely rely on D&B, says Alworth. "D&B reports are important, but bear in mind that many of the disclosures are voluntary and many times they are not completely up to date."

Also, some critical information does not show up in D&B reports. "You want to find out if a business is currently involved in lawsuits or has had judgments against them," Alworth says. Some of this legal information will come to light with a simple Google search on the principal or the company. More detailed information, though, is obtainable from legal services such as Lexis or Westlaw. "These services have the ability to search court records and dockets and perform tax searches," says Alworth. If you are not familiar with these services, it may make sense to ask an attorney or private investigator to search them for you.

One more thing: "You can also check with your Secretary of State to see if the individual has ever closed a business with a similar-sounding name," says Alworth. "This can be a red flag. The individual may have formed a new business just to avoid paying the debts of the prior company."

Beating The Odds

If the risk of a late-paying customer will never disappear, it's still possible to take steps that lessen the possibility of a profit-busting accounts-receivable problem. In these challenging economic times, it's more important than ever to keep billing under control with a vigorous collections policy.

"Have a system, work your system and maintain a businesslike attitude," says Todrin. "And don't be afraid to shut off late-paying customers. It's too expensive not to."

Collecting From Consumers

Dunning consumers can be trickier than collecting from other businesses. "Any organization you hire to perform the collecting on your behalf is subject to the Fair Debt Collection Practices Act," says Gary Nitzkin, partner with Nitzkin & Associates, Southfield, Mich. "The restrictions of the act also apply if your employees appear to the consumer to be working for a third-party collection agency." The text of the act is available on Nitzkin's Web site ( and also on the site of the Federal Trade Commission (

On the other hand if you are the primary creditor collecting on debt owed by your own customers and your employees identify themselves as working for your company, you do not have much to fear when it comes to the federal law protecting consumers. Nitzkin cautions, though, that coming across as a heavy may not be the best way to collect your past due bills. "Successful bill collectors are charming and polite, especially in this environment where so many people are pursuing debt. Likable collectors get paid first."

Approach the consumer with a statement such as this: "We want to keep you as our customer today and tomorrow. We want to partner with you to try and resolve this matter together."

Indeed, the best collection agencies have mastered the cooperative approach so well that they know just the right amount of "schmooze factor" to get the job done. For that reason, it is often more effective, and certainly more efficient from the standpoint of time, to hire a third party to collect your old bills, says Nitzkin. "Unless you are large enough to have dedicated collectors on staff, your people should be spending their time making more sales, not pursuing old accounts."

Hiring the right agency is key. "Ask for references from other happy customers," suggests Nitzkin. Ask those references questions such as these: How long have you had a relationship with the agency? Are you satisfied with the service you are getting? What is their philosophy: Do they use the old strong-arm approach or the new kinder, gentler one?

Then ask how successful they are at getting the job done: How well do they turn debt into dollars? In the collections industry success is measured in what's called the "liquidation rate." That's the portion of dollars turned over to an agency that is successfully collected.

Your best bet, says Nitzkin, is to start the collection process early. "Watch your receivables from the first instance. Beyond 60 days, your chances of collection decline rapidly, and is less than 50 percent after 90 days."

One final thing: Be aware of your state law on debt collection. Some states such as California do have laws protecting consumers from abusive collection actions by primary creditors - even those who do not contract with third-party agencies.

"Your state may well have requirements that go beyond federal law," says Frederick W. Alworth, a director in the business and commercial litigation department in the Newark, N.J., law firm Gibbons. "Be aware that there can be severe penalties for violations. The last thing you want is to run afoul of the law and get on the defensive when someone owes you money."

- P.P.

Recession Raises The Stakes

Collecting gets harder when the economy gets slower. "When things get tough, people start to hold back," says Robert S. Bernstein, a partner in the Pittsburgh-based Bernstein Law Firm and author of Get P.A.I.D. "Even if their businesses are fine they start to get more frugal. People who might have paid in 30 days pay in 45 or 60."

"In a recession, pay special attention to your sales preparation phase," suggests Bernstein. "Take a new look at your credit policies, your pricing and the forms and contracts you use."

Also look carefully at recent transactions made when times were flush. "When business is really good it's a lot easier to let things slide in terms of policies and documentation," says Bernstein. "Everyone is busy selling and people think of granting credit as a way of buying sales."

In a slowdown, use the extra time to look back on those transactions and do a quick review: Do you have everything in place? If you use contracts and you missed something, now is the time to fix it before the deal goes bad, suggests Bernstein. "Ring up the customer and say, 'I was doing a quality review and I see we missed this document. Can I fax it to you to sign?'" Early is better than late: "If a customer has decided not to pay, he will not sign."

- P.P.

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