Handling debts.

Thankfully, having a clear debtor policy for collecting money owed to you will reduce the risk of losing out on unpaid debts. This will help you handle debtors consistently and fairly and gives your customers a clear expectation for when debts need to be resolved.

Being prepared to take a firm stance on persistent late-paying customers could make a huge difference to your cash flow and free up time spent chasing customers.

Consider your options.

Start by asking yourself if you need to offer credit at all. Depending on your industry, having a 'cash only' policy could be no disadvantage to your business. If your customers do value credit options, there are many ways to minimise your risk and shorten your credit cycles.

Here are our top tips:

  • Encourage on-the-spot payments by offering discounts for upfront payments or cash purchases
  • If you need to offer credit, have a maximum limit and try and get a deposit when processing large orders
  • Always conduct credit checks for new customers (Equifax offer this service)
  • Always insist on a signed credit agreement - if you don't have one, your lawyer can help draft one for you.

Once you have determined what options best suit your business, you'll need to draft your own debt-recovery policy.

Draft a debtor policy.

The longer you leave debt uncollected, the lower your chances of ever getting paid. Clearly outline in your policy how long a debt will be allowed to continue before you start recovery actions.

It could look something like this:

  • 7 days overdue - a phone call asking when the account will be paid
  • 14 days - a letter stating the balance owed and requesting action
  • 21 days - a second phone call reminding the debtor of previous requests and your policy on overdue accounts
  • 30 days - discontinue supply (if applicable)
  • 60 days - letter advising that debt will be passed over to a debt collection agency in seven days
  • 67 days - hand the matter over to a debt collection agency.

Keep on top of accounts.

Keep debts manageable by monitoring accounts that are overdue. Review previous payment history to identify potential problems with accounts and use your discretion before any further debt is added to these accounts.

Don't allow a debtor in financial difficulty to use your business as a source of funds. You might be able to absorb a small debt that doesn't get paid but a large one could have a serious impact on your business.

How to collect debts.

With debt collection, make sure you know what you want to achieve before approaching your customer - especially if you still want to do business with them.

List your objectives, covering the following:

  • How much would you settle for?
  • Whether you would accept instalments or flexible payment options
  • How long you are prepared to wait
  • Whether you would allow further charges to their account while the account remains overdue and, if so, how much.
Phone the debtor

The phone provides an instant way to get an answer. It won't generally be as effective as a personal visit but in most cases it may be all that's needed to get some action. A debtor can't ignore the situation if you're speaking directly with them. Make sure you have all the necessary details to hand such as name, payment history, purchases, invoices, etc.

Send reminder letters and emails

Although this method is the most common debt collection technique, it's also the least effective. It's not nearly as personal as a phone call and can be easily ignored. However, it does serve a useful purpose as a polite reminder or precursor to a phone call.

Use a collection agency

As a last resort, you can try legal action or a debt collection agency but it virtually guarantees you'll never trade with that debtor again. In addition, most agencies have a minimum charge so it's only really an option on larger debts. Some collection agencies also use fairly ruthless techniques so choose the agency and the debtors you pass on carefully. Some businesses use collection agencies for all debt irrespective of the history but this only really works for a business with many larger debts.

Debt collection days.

Dividing debtors by your annual credit sales and multiplying by 365 shows how efficiently you're managing your debtors - the result is the average number of days it takes to collect your debts.

You can find your figure for annual credit (invoiced) sales in the profit and loss account. You can find your figure for debtors in the balance sheet. Ignore cash sales for the purposes of this calculation.

Example: Debtors  $40,000
  Annual credit  $260,000
40000/260000 x 365 Average days 56

Your debt efficiency

Aim to collect all debt in less time than stated in your normal credit terms. If your credit terms are strictly 30 days, then any result above 30 in the calculation above should be improved. The more efficiently you collect debt, the better your cash flow should be. A deteriorating ratio shows you're not managing debtors efficiently, so take action as soon as you can.

Things you should know.

The material on this webpage is provided for information purposes only and is not a recommendation or opinion.

The material on this webpage is does not take your particular financial situation or goal into account. We recommend you seek independent legal, financial and/or tax advice.