Article Summary: Many small businesses rely on invoicing and extending payment terms to sell to their customers. Sometimes customers don't always pay on time and you've fronted the money which creates a mess for your cash flow. In the article we cover what you can do as a small business owner to get paid as quickly as possible.
“Metrics that Matter” is a four-part series designed to deliver a pathway and a practice to the most impassioned small business owners. The ones that built their companies not because they had a background in business but a passion for delivering the kinds of products and services they clearly saw a need for delivered at a service level that was missing from the marketplace. This series is designed to empower and elevate you and your team so that you can win the game.
Billion-dollar companies started just like your business or mine: with an idea and a founder. Growth comes from a vision, hard work, a solid culture, care for the client or customer and solid financial management. If this is the magic formula, why isn’t every company successful from the start? Great question!
Each one of these growth drivers: vision, hard work, corporate culture, care for the customer and solid financial management has a methodology, a formula that has companies operate in a manner that sets them on the path to growth. Let’s unpack the financial management piece and focus on one critical element that will help charter your small business growth from startup to mainstay: Collections. I know, surprising, right? You might be thinking “what? Not top line revenue?” No, top line revenue keeps you expanding (like the saying, “if you’re not growing, you’re dying”) but what will keep you in business is collecting what’s owed to you in the shortest amount of time with a consistency that yields an almost boring predictability. I love being bored by money in business. It means that everything is going great. The straight-line path to achieving financial boredom drives right through a company’s policies and procedures around granting credit to customers and the company’s collections process.
Let’s get back to the billion-dollar companies for a minute. These companies had great sales that helped them level up to become the massive 800-pound gorilla in the room. Break-thru sales took them from a small business to a medium sized business and then to an enterprise scale company and collecting the money gave them the fuel to help charter next level results. At each jump in revenue, the risk to the business increased. Growing fast seems glamorous from all the media coverage that a rapidly-growing business receives but know it is inherently risky because it eats like a hungry puppy—it needs more because it’s on a growth trajectory. It means that the business has to use more resources up front to deliver its products or services while payments and the amount of on time payments from customers might be in question if credit rules, policies and procedures haven’t been decided upon, clearly stated and agreed to by the people and companies you’re serving.
What is rooted in collections is the assumption of integrity. When I say “integrity” I don’t mean “good or bad” “right or wrong” I’m referencing structural integrity like the foundation of a building. You can’t put the second story of a building on without a solid foundation. Having a foundation in a building is the structural integrity of that building. Your credit and payment terms are laying out the game of integrity between you and your customers. When making credit agreements with your customers (i.e. giving them a net 30 account) you are saying to the customer that you trust them to honor the terms of the agreement with the expectation that their business will pay in accordance with the terms presented and recognized. They, in turn, promise to honor this agreement and pay you within the timeframe you all set. This is the foundation of integrity in the relationship. From here you can create your cashflow forecasts because it lays the expectation of payments on work performed as per your arrangements.
What happens when the customer doesn’t maintain their end of the agreement? When they don’t pay on time, there is an impact to your business. So nice Mr. Smith who always comes into your hardware store and signs for materials with a net 30 agreement becomes “that bum Mr. Smith” when he becomes a perpetual late payer. When you see Mr. Smith in your neighborhood grocery store, he no longer is that “nice Mr. Smith” he is “that bum that owes you $615 for 90 days.” Anyone who has their own business has a Mr. Smith, “that guy” who doesn’t pay on time and its ruined your relationship because you feel like you and your good nature have been taken advantage of. This is because the relationship no longer has that foundation of integrity. So how do you stop this and keep your business on the path of financial integrity? By putting in credit options, financial controls and payment options so that we can take this tiger by the tail and change how you are an aren’t getting paid on time into how you will get paid on time. Here’s the method to follow so that you move from reactively collecting the money that you’re owed to having proactive policies that have you creating a positive cash flow environment.
First, we’ll start with the metric that helps you understand your current state results and how to improve them:
Days Sales Outstanding
Days Sales Outstanding (DSO) is the holy grail of small business financial management because it is the biggest predictor of cashflow and prognosticator of bad debt—the longer an invoice goes uncollected, the more likely a business will not collect it. Conversely, the more predictable collections are, the greater control you have over managing cash and business expectations. The hardest thing for a business owner to manage is uncertainty. DSO management and analysis helps you understand how much cash you will have for reinvestment or what the profits of the business will be at year’s end.
Controlling your DSO is key to controlling the cash that comes into the business but also holds the line on bad debt. Knowing which customers are paying and when is key to controlling your DSO. Remember, our goal is predictability. When we can know when and how much we’ll be getting paid, business and finance planning becomes a much easier task.
Setting Up Credit and Collections Best Practices
Setting up the rules of engagement—how customers are going to pay for your products or services is key to your business model and the conditions for your cashflows. Some business customs dictate how your customers will pay. Diners in a restaurant sit down to a meal, collect a check at the end of the meal, pay the check to the waitstaff and then leave a tip. There is an implied agreement between diner and restauranteur that payment will happen once the diner is served. Fast casual dining has you pay when you order and often before you pick up your own food order. Still the conventions of these kinds of transactions is cultural and implied by industry. But what if you are a service company: a plumber, a marketing agency, an executive coach or other service provider that may or may not use materials or deliver a product with a service attached? Plumbers who fix a sink faucet bring talent and skills to a repair job but also a small inventory of parts that they’ve already paid for at the plumbing supply house. Should they offer to send an invoice and wait for payment from a new customer? Let’s look at this question: does the plumber know this customer and have a payment history with the customer? Does the plumber have to lay out money to service the customer? Is the plumber replacing broken parts with new parts that s/he paid for and put in inventory? Does the fee for fixing the faucet include administrative time to make an invoice, sending it to the customer, send a reminder notice that the bill is due or any collections fees that it might cost the plumber if s/he needs to hire help to collect the bill. Does the plumber have to offer terms to the customer as part of a customary and implied way of doing business like the restauranteur? No, the plumber isn’t obligated to offer the new customer any credit—the offer of sending an invoice with the hopes that they will be paid in a timely manner is not a requirement in this case. A great cashflow environment is made by devising the rules of the game, setting customer expectations and having those terms be adhered to.
Create the terms that are the safest for you as the business owner. Collecting payment for services at the time when they’re rendered removes the risk of non-payment. That means there is no credit being offered to the customer for the kinds of one-time services like fixing a leaky faucet. Accepting credit cards and adding the service fees into your overall pricing will more than pay for itself by your ability to collect your money immediately. If it’s a large job with progress payments, create a payment schedule and method of acceptable terms for payments (credit card, business check, cashier’s check, wire transfers etc…). Don’t assume that the goodwill of the customer will have them stick to your terms. Like my mailman, Robert, always says “making sure you’re keeping honest people honest.” That’s what clear payment terms are along with payment methods.
Setting customer expectations for payment options
Pre-determining how your transactions work best for you will help you set expectations for the customer. You might let the customer know when they set the appointment that services rendered need to be paid for at the time of delivery. You can tell them about the types of payments that you’ll accept from them (cash, credit card, check, PayPal, Square, Venmo etc…). Accepting numerous payment types helps you bridge the gap between what you need to make your business run (cash) and what kinds of payment methods the customer has at their disposal. Offering payment options helps customers feel comfortable in paying with a method they feel most comfortable with. It also will get you paid. In the past, many small businesses didn’t want to accept credit cards. Understanding that there is a financing fee (per swipe charge, percentage of transaction and perhaps a monthly service charge ) for accepting credit cards and other methods of cash collections like PayPal or Square carry a cost to your business overall, you can factor this cost into your pricing having the customer’s fees pay for the financing charge you will incur for every transaction. This way, the financing charges are already accounted for in your pricing and it doesn’t mean that you’ll be losing margin by using them.
Service providers that deliver a unique and hard to duplicate service like executive coaches bill clients by a retainer method that is outlined in their contract. They often stipulate that the client pays for services before the service is delivered. If payment hasn’t been received by the coaching business as per the contract, the coach isn’t obligated to deliver any services until payment has been rendered. This is a way to ensure that the value of the coach’s time is respected and that they don’t have the risk of not getting paid by a client. Being paid on retainer prior to delivering service means that there is no risk to the business owner—and that’s the kind of safety we like in our transactions.
Checking references before offering a Net 30 deal to your Customers
Using an agency like a Dun & Bradstreet isn’t a pathway that most small business owners take and for good reason—the benefits that a small business can derive from the service might not outweigh the fees. So, ask for trade references—your new customer should be able to provide you a few references to check on their payment history. When they give them to you, make sure you follow up and call those references. Tell your customer that once you do a credit check, you can determine if you’ll offer them credit. Once you do check, you will know if you want to offer them credit and if you do, what is the limit that you’ll offer them. Remember, anytime you offer credit, you will be taking a risk on your customer’s ability to pay. Again, there are some businesses like raw materials suppliers where offering net 30 is the lingua franca of the industry and if this includes you and your business, make certain that you check references and check in with your finance department to know who is paying on time and who is “that guy” who isn’t paying as agreed. Remember, you can always change the terms of your credit outlays if your customer isn’t honoring the payment terms that have been agreed to.
Offering terms: why net 30 really is net 45 and net 60 is really net 90
Many small service providers make this start up mistake: offering terms to new customers when they can’t afford to offer terms. We think offering terms is another way of being polite and is the best way to open doors for new business. This isn’t the way for a new business owner to limit their risk and make certain they are paid for the work they perform. Only offer terms if you can afford to take the risk of your customers not paying the balance of what they owe you.
Collections situations happen when a customer can’t pay, is paying other vendors or creditors or pushing you down to the bottom of the invoice pile because they’re receiving pressure to pay from other creditors. Some of the best coaching I ever got was from a fellow entrepreneur who told me to tell a very slow paying client that they needed to “disappoint someone else” and to pay me what was owed to my business instead of pushing off our bill for another vendor’s. I was constantly disappointed by this client’s lack of timely payments—even though they agreed to the payment schedule and had the ability to pay. For whatever reason, this client kept putting our invoice on the bottom of the pile. It would take a threat of ceasing services that then would force the client to pay. We ended up rescinding their credit with the company and put them on an autopay plan using their credit card. In doing so, we removed the risk of non-payment and the cost of our in-house collection efforts from our Accounts Receivable department.
Accept Credit Cards
Credit card processing fees are not the best part of accepting credit cards as a form of payment. Getting paid in a timely manner is. To make up for the cost of financing, build in the financing charge into your pricing as discussed in a prior. Yes, the financing costs do add up fast here, however, it removes the burden of collections that you might have to do with a client. Think about how much wasted time you or your finance team spends doing collections—weigh that against accepting credit cards for payments. Credit card fees are looking better, right? Using services like Square and PayPal give your customer other payment options when they don’t want to have to let go of their cash on hand. This might have them buy more products or services from you if they know that they can manage their cashflow.
What if You’ve Offered Terms and Now You Can’t Collect?
Using a collection agency as a last ditch effort for small business can be a way to at least recover a small amount of your outlay for a non-paying customer. It means that you’ve tried everything you could to collect the money in-house and now you need outside help. Working with a collections agency means most businesses have two options in contracting a collection’s company: the first option is giving them anywhere from 30% to 50% of the amount that they can collect from your very late payers. The second option means that you’ve sold this debt for pennies on the dollar in hopes of recovering some of the money that you’ve laid out to deliver the products or services that the customer ordered but for some reason cannot pay for. Determining what’s best for you and your company will be checked on a case by case basis.
No one wants to think about losing the money that you’ve invested in good faith that your customer will pay you for the goods and services that you’ve already delivered. Let’s think about it in theory. What do you do if there’s been a material change in the condition of the customer’s business? By material change we mean that when you offered them terms the business was humming along, they had a good track record of paying other vendors (you know because you’ve checked their vendor references) but now something has happened and they’ve gone from a source of reliable orders and payments to a customer that can’t meet their obligations. Sometimes events occur that businesses may or may not have control of (remember the financial crisis?) and it negatively impacts their ability to pay.
What about the customers that are now past due but aren’t worthy of sending to a collection agency?
There are a number of ways for you turn a negative into a positive and then turn this positive back into positive cashflow. Using a variety of these techniques can get you on the right road to payment.
Communication and Customer Experience Impacts Payment Frequency
Communicate with your clients about their customer experience on a frequent basis. Knowing your customers and their likes and concerns will help you service them better. They, in turn, may move you up on the “pay list” with the companies that get paid no matter what, even when cash is tight. This is the kind of insurance people and companies get with the “golden rule.” Treat others the way you’d like to be treated. For all of the tools, tips and techniques around collecting what’s owed to you, bringing a genuine empathy to the customer relationship pays off in intangible ways with positive feelings and tangible ways like always getting paid (and impacting positive cashflow).
Look for Solutions to Help Your Late Payers Get Their Bills Paid
“I love being a deadbeat, not paying any of my bills on time and getting collections calls” said no one ever. When your clients are late paying and you have to consistently call them for payment, know that they are suffering. Positioning the payment issue as a problem that you might be able to help them with may change their attitude about working to get your bill paid off. Working together to solve a problem takes away the judgment and the moral dilemma of your slowest paying customer. Sometimes people make no payments if they think you’ll need the entire payment right away. If they need to cut the payment in two and you’ve got the ability to do this with them, you can make suggestions like paying 50% now and 50% in a week when they get paid from their customers. Showing kindness and consideration for those customers who are having a cash flow crunch can buy you a lot of good will. As a business owner, you know that these cash flow crunches happen. It’s not if, it’s when. Offering some compassion and understanding will get you far ahead in the collections game. Remember, you do get more bees with honey than with vinegar.
What about the late payers who are late payers by “choice?” Some of your customers will believe that it is there right to pay you late. That the terms posted clearly on the invoice are not about them. Sticky situation, right? You want to keep a positive attitude towards your customers but when they don’t pay you in a timely manner, you might begin to resent them. They might start avoiding you. You can have a conversation with them about what’s going on in their business and assess if they’re sharing honestly with you about the circumstances. Ask them if there is something missing that you could do to make them a happier customer? What’s in the way of them expediting payment on the oldest outstanding invoice? Did they know you accept credit cards? Is this a better method to be using instead of the net 30 credit offering you’ve been giving them? Suggesting a solution and having the late paying customer choose another method of payment can empower them and get you paid faster.
Whether it is a good customer having a hard time paying their bills or a customer that might be taking advantage of your good nature and your payment terms either situation engenders actions around collections that mix “money and honey.” The big idea here is that you can relieve pressure on the customer about their outstanding debt and working with them to support a solution that has your agreement be back in integrity. It feels better when we’re not in a situation where there’s pressure and concern and for that, it makes the transaction sweeter.
We’re mixing money and honey and it’s a win-win when we can do that for our customer. After all, we don’t know when the shoe might be on the other foot and we’ll need some help in making payments if for some reason the economy goes sideways and it impacts us. There’s a saying in small business “everyone gets a turn” and that’s about being on a rollercoaster going up and going down—no one is immune to the business cycle. It’s better to help someone now and in turn, you’d hope someone will help you in the future.
Making a Successful Collections Call
Before you get on a call familiarize yourself with the customer’s account. Know how long they’ve been a customer, understand their payment history (is this the first time they haven’t made a payment or is this an ongoing situation?), look to see if you have a personal relationship with the customer or if they’re “new to you”, find out the total owed and if it’s one or many open invoices. Determine before you make the collections call how much your want (hopefully, the full amount) and what you’d accept (maybe 50% of the outstanding balance). Now that you know the situation, you’re ready to make the call. First, thank them for their business. Tell them that you’ve appreciated their loyalty and thank them for their good payment history in the past. Ask the person if there’s something specific that is impacting their ability to pay. Tell them that you need to be paid and tell them the total amount. If they say they can’t pay the total amount, ask them what they can pay. Never get off the phone with a late paying customer without getting some kind of commitment to pay. Collect the money on a credit card, get the money wired or have someone pick up a check if its local business and the amount makes a difference on your cashflow. Thank the person for working with you on solving the problem together. Tell them how much you appreciate them.
How to Prevent a Small Delay on a Very Big Invoice
Wouldn’t it be great if you never had to do a collection call? One of the best techniques I know to use for the kinds of invoices that impact your business’ cashflow and your ability to pay your vendors is to preemptively call the accounts payable department of your big customer and ask them if you can expect their payment on time. Sometimes these customers might have a tendency to be a few days to a few weeks late. If this is the case, creating a relationship with the accounts payable department at your customer’s office could be one of the most valuable relationships that you cultivate at that company.
“An ounce of prevention is worth a pound of cure,” as the saying goes. Don’t be embarrassed to ask these questions, “can I expect payment for invoice number 123 on the day it is due? Have you put our invoice in your payment queue? Is there anything in the way of having us be paid on time? Is all the documentation that you need in order to pay me provided and complete? Make sure the accounts payable department person (often, it’s a small group of people paying vendors) knows your situation. It might give you “most favored nation” status whereas you get paid first instead of with the rest of the pack or worse.
Achieving “Financial Boredom” Through Seamless Payments and Positive Cashflow
As a wise business person once said “we train people how to treat us.” Creating a seamless payment and positive cashflow environment is all about rules, protocols and relationships. Seamless payments like scheduled credit card payments or collecting your payment when services are rendered or working on a retainer method can take away the headaches of collections, reduces your average DSO for your company and keeps the relationships that you have with your customers clean. Making certain that you get paid for the work that you’ve done not only makes you feel good as a person but it also keeps the financial foundations of your company solid which means you’ll be able to forecast cashflows and the predictability of payments from your customers. In doing so, you’ll show a regularity of results that becomes ingrained in the financial underpinnings of your business. Yes, it might create a boring scenario but that’s the kind of boredom any business owner would like—I expect that you would too.
It’s Math and Honey
Running your small business takes a few key performance indicators like DSO to regulate the results that best support your success. It’s simple math that helps you understand your business results. The personal relationships that you foster helps drive those results. It’s the honey that makes running your business so sweet.