While managing cash flow is always important, the recent economic turbulence has renewed interest in this topic. Businesses have begun to focus (to an even greater extent) on ensuring that clients and customers pay what they owe when it is owed.
This article will outline some techniques that a business can utilize in developing a proactive system to decrease bad debts. (Please note: specialized tools such as contractors and the Construction Lien Act are beyond the scope of this article.)
The starting point in analyzing a business’s bad debts is the sales that led to the extension of credit. It could be said that there are four stages of a sale: (1)pre-sale; (2) sale; (3) post-sale; and (4) a salvaging phase.
1. Pre-sale stage: “Early and often”
Having proper systems
Businesses too often treat cash flow management as an “as needed” item or on an ad hoc basis, which is only slightly better than doing nothing. It is extremely important to have proper and proactive systems and processes in place. These include implementing invoicing software, an accounting system and a billing process to optimize efficiency. Another precaution is to consider obtaining trade credit insurance.
Qualifying the debtor
Be selective in choosing with whom you do business. Taking time to pay you means your customer is receiving financing, and guess what, you’re the bank! Giving proper consideration and researching potential customers, especially those who are making larger purchases, before granting credit will save time (and money) down the road.
When researching a potential customer’s business consider, amongst other things: how long the business has been established, how and from where the business is being run, what the business’ customers think of it, and whether its suppliers are reliable. For instance, ask potential customers for trade references, including from banks and professionals, and actually contact these references; join industry and trade group associations; and conduct credit checks.
2. Sale stage: “There’s no time like the present…”
It is important to be open and transparent at the outset of a relationship, so as to avoid misunderstandings in the future. It is advisable to document the understandings in an engagement letter or a formal contract, or even by posting payment terms on a website.
Structure payment terms
As a starting point, always ask for a deposit as this helps cash flow and, as a screening tool, eliminates clients who are unlikely to pay in the end.
Do not wait until the end of the assignment to bill customers. Billing upon achieving certain milestones (e.g. when the job is 50% completed) is a good strategy to retain leverage and get “as much cash in the door” as possible. Billing on a timely basis will help with cash flow and to establish expectations.
Incentives and disincentives
Use “carrots” and “sticks”; that is, discounts can be offered for prompt payment and interest and collection expenses can be imposed for overdue payments.
Discounts have many benefits as they enable you to entice clients to pay early but also provide insight into which clients have healthy cash flows and, on the contrary, which clients you should be concerned about.
As per the Interest Act, the right to charge greater than 5% interest on late payments must be specified in the invoice or contract. Further, penalties must be expressed on a per annum basis. Reserving the right to recover collection expenses (such as legal fees) should also be considered.
When entering into an agreement, you should consider obtaining security. Depending on the business, security may be taken in personal or real property; however, you will typically have to register a financing statement or mortgage to perfect the security interest.
The goal of an invoice should be to receive money quickly and efficiently. Specifically, an invoice should have the payment due date, information on the goods and services supplied, the mailing address, the corresponding purchase order or contract reference, and the required provisions, such as interest for overdue payments. In addition, consider the most effective way(s) to send an invoice and determine the best time for sending it (e.g. when the customer is “in funds”). Finally, be flexible in how customers may pay (e.g. VISA, AMEX, wires, EFT payments and cheques) so as to increase the likelihood of prompt payment.
Due to the difficulties associated with “verbal arrangements”, especially if the relationship or the customer’s business sours, businesses should require a written agreement for every material project. As stated above, the client should always acknowledge and confirm what they are receiving, how much it will cost, when the sum is owed and any repercussions for late or non-payment. To that end, standard legal provisions (a.k.a. boilerplate) are extremely helpful; a few key standard provisions to consider including in your contract are: an entire agreement clause, a cap, a disclaimer, a waiver of implied warranties, limited damages clause, a dispute resolution clause and governing law of jurisdiction provision.
3. Post-sale stage: “Keep your eye on the ball!”
Once a sale is completed, unless all money is received upon or prior to completion, there is still work to be done.
- To be alerted to potential problems early on, analyze and stay on top of numbers and trends in your customers’ business/industry(hence the importance of an accounting or early warning system).
- It is helpful to get to know the cheque writer and accounting staff at your customer’s business as these people can provide important information when you are waiting for a payment.
- Situations should be personalized and elevated within the customer’s organization as required.You should use leverage and stress points if available.
- It may be helpful to appoint a “bad cop” to deal with the client so as to create a separation between yourself and the issue of non-payment.
- It is prudent to keep a journal of the correspondence between your business and customers so as to have a record in case a situation worsens.
4. Salvaging phase: “A bird in the hand…”
Time is of the essence at this stage.
It is imperative to have a clear policy for recovering bad debts. It is important to promptly and consistently show the customer and the market that debts will not be forgotten and the business will not give up on monies properly earned. Sending reminders, making calls and sending demand letters are all things that must be done. At a minimum the business should stop performing new work or taking new orders from the client. However, in the event that all else fails, the debt should be assigned to a collection agency or legal counsel. Sometimes the threat of further action (and the damage it could cause to a business’ credit rating) is enough to lead to a payment. The above being said, you should always be open to strike a deal with the client so as to resolve the situation.
This article provides only general information about legal issues and developments, and is not intended to provide specific legal advice. Please see our disclaimer for more details.