You’ve got a small business. Your team is killing it in sales. Orders are pouring in. Business is crazy and you’re making money.
Accounts Receivable is where your clients actually become your clients. It’s not until after someone pays that they become your client.
When you send an invoice, 90% – 97% of clients will pay…. eventually. (I know, this is a generalization, the percentage will differ slightly based on industry and there are some industries that this doesn’t apply to….keep reading)
On the flip side, this means that 3% – 10% of your invoices won’t be paid (or will be written off). Now, that’s not so bad at face value. Especially if you have a fairly high profit margin and you’ve already worked it into your loss ratio.
Lets dig a little deeper. The average profit margin in the nation is 10% (go with me here, every industry is different). If your invoices aren’t paid and 10% is profit, that means you’re the remaining portion of your invoice (90%) should be getting allocated to overhead, actual product, and manpower/payroll.
You now need to sell 10 more identical deals (and get paid on all of them) to just break even on the one account that didn’t pay.
This chart shows how much more you need in sales to make up for accounts receivable write offs.
How do you improve cash flow and minimize writing off bad debt?
I’ve got 3 steps.
Create an AR Process that works for your business. This means it’s a process that will be done each month – it won’t be successful if you don’t actually do it EVERY MONTH. Every account that is past due will go through this process. An example of an AR Process:
- Assume net 30 terms
- Day 35 – Statement of account is emailed, reminding client they are past due.
- Day 45 – Reminder call, ask for payment over the phone.
- Day 60 – Statement of account, explain that non-payment leads to account placed on hold and account sent to collections.
- Day 75 – Call to client explaining that non-payment leads to account placed on hold and sent to collections. Encourage to pay over phone or send check same day.
With this first step – you’ll be able to strategically collect most of your accounts. There will still be several that don’t respond or don’t pay. The next steps use outside vendors to assist in collecting past due invoices. Sending accounts to outside vendors between 90 – 120 days will provide the most success to you.
This service is provided at a flat rate ($13-$15 per account). There is no commission on what is collected and a vendor that provides this service should be directing all payments to you. Pre-collections is an automated series of demand letters that are sent to your client encouraging them to pay you. Most Pre-collection services report a success rate of 30-50% of accounts submitted.
You’re likely familiar with traditional contingency collections. The cost involved is based on what is actually collected. Typical firms charge between 20% – 50% depending on the debt. If the firm doesn’t collect, then you don’t owe anything. When they do collect, they keep their percentage and you receive the balance. Most agencies, if they are unable to collect through traditional methods, will recommend a collection attorney. Collection attorney’s also work on contingency. Depending on the debt, moving forward with legal action may be advisable.
Going through these 3 steps – you’ll see unpaid invoices decrease dramatically.
There are likely key clients that will be given more time to pay, and have more touch points like phone calls. You will be able to use these steps and adjust for your client base and comfort level.
What’s the downside?
Fear: you may be afraid to be too pushy or alienate your clients. This is valid and when these steps are followed with professionalism and respect, your clients will understand. Keep in mind, they aren’t your client if they don’t pay you! Using all of these steps will set up boundaries with your clients and reminds them of the value you offer them.
Loss of a client: losing a client is a real thing. Reminding about payment, asking for payment, using outside vendors to encourage payment….these steps will assist in “keeping” clients. If you are losing clients because of non-payment, then AR likely isn’t the only problem and you may want to go back to review your sales approach.
Additional internal staff: if you don’t have a full time employee responsible for the whole AR process, or if that person is overwhelmed, there are services that can help you for a fraction of what another employee would cost.
Putting it all together
A good AR process will increase your cash flow and increase your profitability. Accounts that are collected move from your loss ratio column directly over to your profit column. Keep your money – your clients should be your clients!
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