Article Summary: Many small businesses rely on invoicing and extending payment terms to sell to their customers. When extending payment terms to your customers, be sure you have a small business collections process in place. Sometimes customers don't always pay on time and you've fronted the money which creates a mess for your cash flow.

small business collections process

In this article we cover:

  1. How to set up your small business collections process if you're a new business
  2. How to improve your current small business collections to get paid in a timely fashion
  3. How to escalate the collections process with late-paying clients 

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 customer and solid financial management. If this is the magic formula, why isn’t every company successful from the start?  Great question!

Successful companies master the methodology behind each of these growth drivers. 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: the small business collections process.

I know, surprising, right? You might be thinking, “What? Not top line revenue?” No, top line revenue is key for expansion, but what will keep you in business is collecting what’s owed to you in a consistent and timely fashion 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-through 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 it is inherently risky because growth eats like a hungry puppy. It means that the business has to use more resources up front to deliver its products or services while waiting on payments from customers. These payments might be in question if credit rules, policies and procedures haven’t been decided upon, clearly stated and agreed to upfront.

What is rooted in the small business collections process is the assumption of integrity. When I say “integrity” I don’t mean “good or bad” – 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. 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. 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 cash flow 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.  Anyone who has their own business has a Mr. Smith, or “that guy” who doesn’t pay on time and has ruined your relationship. 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 ensure you 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 create 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 cash flow 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 know when and how much we’ll be getting paid, business and finance planning becomes a much easier task.

Best practices for setting up your small business collections process

Setting up your small business collections process—how customers are going to pay for your products or services -is key to managing your cash flow. There are some business customs that 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 meal has been served. Fast casual dining, on the other hand, has you pay when you order and often before you pick up your own food order. The conventions around 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 dig into 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 cash flow 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, “make sure you’re keeping honest people honest.” That’s what clear payment terms are along with payment methods.

Set 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, 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 that they are most familiar with. It also will get you paid. In the past, many small businesses didn’t want to accept credit cards. However, you can build the financing fee (per swipe charge, percentage of transaction and perhaps a monthly service charge) into your pricing. This way, the financing charges are already accounted for in your pricing and it doesn’t mean that you’ll be losing margin by accepting credit cards.  Additionally, 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?

Service providers that deliver a unique service, like a consultant, 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. The consultant isn’t obligated to deliver any services until payment has been rendered. This is a way to ensure that the value of the consultant’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 as part of the small business collections process

Few small businesses will check a new customer’s credit history by checking with an agency like Dun & Bradstreet as part of their small business collections process. The benefits that a small business can derive from the service might not outweigh the fees. Instead, a best practice is to ask for trade references—your new customer should be able to provide you a few references to check on their payment history. Tell your customer that once you do a reference 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 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.

How to improve your current small business collections process

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.

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 paying off the outstanding bill. Sometimes people will avoid making 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 their 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. For example, ask them:

  • Is there 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?

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 get their account current. 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 that “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.

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 to ensure that you get paid on a large invoice is to preemptively call the accounts payable department of your 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 the following 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.

How to escalate the small business collections process with late-paying clients

Collections situations happen when a customer can’t pay or is pushing you down to the bottom of the invoice pile because they’re receiving pressure to pay from other creditors. There are a number of ways for you turn a negative into a positive and then turn this positive back into positive cashflow.

For example, I once had a client who chronically paid us late —even though they agreed to the payment schedule and had the ability to pay. Some of the best coaching I ever got was from a fellow entrepreneur who told me to tell this 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. 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 terms 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.

Read on for a few other techniques to include in your small business collections process to help get your clients on the right road to payment.

Making a Successful Collections Call

Before you get on a call familiarize yourself with the customer’s account. You should know, for example:

  • How long they’ve been a customer
  • Their payment history (is this the first time they haven’t made a payment or is this an ongoing situation?)
  • If you have a personal relationship with the customer or if they’re “new to you”
  • 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 it’s a local business. Thank the person for working with you on solving the problem together. Tell them how much you appreciate them.

Using a collections agency

Use a collection agency as a last ditch effort in your small business collections process. It means that you’ve tried everything you could to collect the money in-house and now you need outside help to recover a small amount of your outlay for a non-paying customer.

When working with a collections agency, you typically have two options:

  1. The collections agency keeps anywhere from 30% to 50% of the amount that they can collect from your very late payers.
  2. Sell this debt for pennies on the dollar to the collections agency 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.

Either way, you typically won’t recover anywhere near the full amount back from your customer. Determine what’s best for you and your company on a case-by-case basis after making every effort to get the customer to pay via the methods outlined above.

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 cash flow environment is all about rules, protocols and relationships. Make your payments seamless by scheduling payment via credit card, collecting your payment when services are rendered, and working on a retainer method. This can take away the headache of collections, reduce your average DSO for your company and keep the relationships that you have with your customers clean.

Keep your business finances solid by making certain that you get paid for the work that you’ve done. By doing so you’ll be able to forecast cash flow with predictable customer payments. 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.

“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.

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