Guidelines for Managing Receivables

Guidelines for Managing Receivables

Chasing unpaid invoices can be a time-consuming, stressful and frustrating process for any business. In addition, mounting debt and unpaid customer invoices can cause cash flow constraints for the company as it will be unable to meet its working capital needs.

Most businesses trade with their customers on credit basis. This means that customers purchase goods or services and pay at a later date. Trading on credit basis is used because it encourages sales and stimulates business growth. However, any time a business trades with its customers on credit basis the business is exposed to the risk of late payment or default which can disrupt cash flows.

Organizations will usually provide their customers with payment period terms of NET 30 or NET 60 days to pay off their invoices. While some customers will pay on time, others may delay or default due to reasons such as lack of money, they misplaced/forgot about your invoice, they keep postponing/putting off the payment, or other issues. To prevent such occurrences it is necessary for your company/business to put in place methods, processes and tools to manage its debtors and credit based payments.

This document will provide you with some practical guidelines to manage how you extend credit to your customers, how to prevent mounting debt/unpaid customer invoices, and how you can effectively collect overdue payments from customers.

1. CHECKING THE CREDITWORTHINESS OF NEW CUSTOMERS

Determining the creditworthiness of new customers before extending credit to them is paramount to reducing financial risk. This is because it will ensure that your company only extends credit to those people and businesses who it believes can pay on time. The 5C’s is a well-known technique that evaluates the creditworthiness of a potential client based on character, capacity, capital, collateral, and conditions. These factors focus on the customer’s reputation for paying on time, capacity to continue paying, revenues and outstanding obligations, the company’s future business prospects, and trends within their industry that could affect their ability to pay.

Character analyzes how credible, dependable and trustworthy the customer is. To assess character, review the business’ credit history (such as credit reports and credit scores), contact a business’ references, and analyze the business’ reputation in the industry.

Capacity is the business’ ability to repay debt and is evaluated by looking at the cash flow statements, debt-to-income ratio, historical revenue, and payment history. A debt-to-income ratio lower than 36% is considered ideal.

Capital is represented by the total funds and assets the company owns. To assess the creditworthiness of a new customer, evaluate their investment in fixed assets, and review their bank statements and financial statements to gain insight on their capital reserves. Growing capital reserves is a sign of less risk and higher ability to pay.

Collateral are assets held by the company that can be sold to settle debt. During the creditworthiness analysis, identify assets (such as inventories, real estate and accounts receivable) held by the business and that can be easily liquidated to repay debt.

Conditions are the threats and opportunities in your customer’s industry as well as the economic and political situation of the country they operate in. This evaluation will provide a clear picture of whether the business will continue to be viable or if there are challenges that would affect its liquidity or going concern status.

1. PREVENTING DEFAULT OR DELAYED PAYMENT

To avoid situations where customers delay paying amounts owed to you or default in payment, consider applying the following guidelines.

1. Clearly Outline Your Payment Terms

Clearly outline the terms of trade and credit at the start of the engagement or during contract signing. Once you establish the customer’s terms of payment, invoice accordingly to ensure they receive the invoice well before the due date and to avoid delays.

2. Invoice Customers Promptly

Encourage prompt payment by:

• Sending out invoices as soon as the product or service is delivered, or on a regular date.
• Clearly stating all payment options and information on your invoices or contracts.
• Keeping in regular contact with your customers.
• Offering a small percentage discount for early payment.

3. Have in Place Credit Control Policies and Procedures

Develop Standard Operating Procedures (SOPs) for your credit control processes and accounting and finance procedures to ensure that nothing is left to chance. Ensure that sales staff have access to the SOP manuals and are well versed with the content, understanding your business’ payment terms, customer invoicing and debt recovery procedures. Ensure that every new staff member reads the SOP manuals as part of their induction.

Reward sales staff for payments collected rather than only at the point of making the sale, to encourage them to follow up on payments due.

4. Perform Credit Checks

To increase the possibility of trading only with customers who are creditworthy, implement the following processes:

• Do a thorough background check on a business before you offer goods/services on credit.
• Set safe customer credit limits.
• Wait until payment clears before shipping or releasing more goods.

5. Understand Supplier Relationships

Know your role, power and position in the customer’s supply chain in order to manage expectations accordingly. If you are a small supplier in their supply chain, you may not have power to influence decisions and operations.

In addition, if you are hoping for a long term relationship with the customer, taking legal action against them for unpaid invoices may not be the best approach.

6. Chase the Right Person

Ascertain the appropriate contact persons within the client organization when it comes to chasing for payment. You may find that you receive payment quicker if you establish contact with a member of the finance team.

7. Have a Debt Management System in Place

Your contract with the client should detail the debt collection process to ensure that the client is well informed of the consequences of delayed payment and to prevent confusion with the client. The contract should also clearly stipulate the late payment fees to be paid by the debtor in order to compensate the creditor for any additional costs when they happen.

8. Establish Clear Communication with Debtors

Essentially, the debt recovery process should be initiated once the invoice is more than 90 days overdue. Companies can however contact customers before the 90 days by sending polite reminders in order to establish good client relations. Sending a friendly reminder or giving a courtesy call is usually enough to prompt the customer to pay you. Establishing good client relations will also provide insight into the debtor’s financial situation and help to resolve payment problems before taking legal action.

1. RECOVERING OVERDUE PAYMENTS

Sometimes, late payments will be unavoidable and it becomes necessary for your company to implement a debt collection process in order to get the invoices paid as soon as possible. Highlighted below are some basic steps in the debt collection process.

1. Send a Friendly Payment Reminder

When the payment first becomes overdue, send a polite reminder by email or make a phone call to the customer. They may have forgotten about the invoice or it may simply have been an oversight or temporary cash flow problem, therefore this first reminder may be enough to get payment from the customer.

Ensure you include payment details, options, and contact information to make it easier for the customer to pay promptly.

2. Send an Overdue Payment Reminder

If there has been no response to the first reminder and the invoice remains unpaid, reach out again with a second email or call reminding them of the money owed and requesting payment.

3. Send the Final Notice

If payment is still pending, send a final reminder email or make the final reminder phone call to the customer to discuss the outstanding invoice and request for payment.

4. Try to Make Contact with the Customer

If the client has still not paid, consider visiting their premises in person as this will reflect a better image of your company and builds a client relationship that could be useful in future debt collection activities.

5. Consider Using a Debt Collection Agency

You may resort to using a debt collection agency who will follow up and collect outstanding amounts on your behalf. The debt collection agency will do their research and analyze the debtors’ financial situation in order to establish the best plan to obtain the debt. Working with a debt collection agency may be more effective as the business can get their money paid faster.

6. Send a Formal Demand Letter

Sending a formal demand letter should be used as an action of last resort when all other attempts have failed. The demand letter will contain details of the debt and inform the debtor that if the debt is not paid off in a certain time frame legal proceedings will be instituted.

It is prudent to try and meet the debtors halfway, give them options, and adjust repayment plans to their situation before implementing this route as it could potentially damage the business relationship.

7. Take Legal Action

Once the formal demand letter has been sent and payment is still not forthcoming, a claim may be submitted in court. The court will send the debtor notice to pay the debt and interest incurred within a certain period of time. This process may however take time if the debtor chooses to defend the claim.