Bullet Proof Your Business

Cash Flow – and Debt Recovery

The biggest risk in any business is insufficient cash flow. Without cash flow, a business will not have to worry about fraud, theft or staff problems. Its biggest problem will be handling creditors who will serve it with Statutory Demands and the like due to non-payments.

Cash flow is usually closely related to debtor control or recovery. This is, and can be, the coordination of many initiatives or a system to get your clients or customers to pay – quickly.

We saw a breakdown of such a system in a client’s business, which was struggling because it had no cash flow. The owner, Mandy, suspected that her book-keeper and staff were stealing from her and causing the business to struggle, and she engaged us to investigate. After auditing the books of account, reconstructing expenditure, reconciling and speaking with a random sampling of service providers, we could not identify any irregularities. Operational and administrative systems also seemed adequate in terms of risk prevention.

Of note was the fact that Mandy’s business had a large book of debtors. Sometimes it ranged to nearly $1 million. She also ran a sizeable overdraft. We closely examined the debtors and came to the following conclusions:

• 45% of the debtors’ book was 45 days overdue. This needed to be fixed.
• Although invoices were completed with every job, no monthly statements were forwarded to clients. Most businesses only pay on end of month creditor statements.
• There was no follow-up correspondence, calls, enforcement or legal proceedings for those who did not pay, or pay within a reasonable time.

It was obvious that Mandy was hurting, not through fraud or theft, but because she could not collect her debts in a timely fashion. Her overdraft interest was mounting and compounding her cash flow problems. We explained to her how a debt recovery, or creditor control system, should work and over the next week we implemented one in her business. Many of the strategies documented below were put in place.

We found out, however, that Mandy had one big problem in properly implementing this new system. During our audit of her books of account, we noticed a suspense account with more than $240,000 in it. She also informed us that clients were disputing the first monthly statement forwarded to them, saying they had paid part of their outstanding account.

It was clear that Mandy’s book-keeper had been lazy or incompetent and had entered many payments into the suspense account instead of applying them against the exact outstanding invoice. It became embarrassing for Mandy to forward statements or reminders to clients who had already paid their accounts.

There was only one thing to do. Mandy audited the suspense account and reconciled it with her bank deposits, and the clients’ outstanding accounts. This was a large but necessary task and it cost Mandy $12,000 in extra book-keeping fees. It was necessary, however, because Mandy knew exactly what she was owed – about $700,000. Knowing that her records were accurate, she was confidently able to implement our full system of debt recovery and credit control.

Within three months, her debtors were down to $380,000. Mandy implemented the full system and applied it. Strategies included full and proper disclosure of fees prior to work, money upfront where possible, terms explained in writing and acknowledged in writing by the client, immediate invoicing, monthly statements of account, follow-up calls, collection of late or bad debts, legal action and enforcement action.

After 12 months she had less than $100,000 in her book of debtors. Mandy no longer has a cash flow problem and has expanded her business from 22 staff to 35 staff.

Debt recovery

Debt recovery is one of the most important parts of any business. All businesses have expenses that need to be paid. Without customers paying their invoices you may also become a bad debtor.

A key point about debts is how much they are worth to your business. If you have a 10% profit margin and you decide to write off a $500 debt you have written off $5,000 worth of sales. If you have a bad debt you need to resolve how far you are willing to go to recover that debt. Most debts will be paid, but the deciding factor is how much effort you are willing to invest in the recovery of that debt.

When a debt is sent to a solicitor to recover, they can be successful in recovery before the matter needs to go to court. Your solicitor will quickly find the debtor, contact them, and make a payment arrangement with the debtor.

However, the longer you wait to attempt to recover a debt, the lower your chances. You need to keep the customer close and speak to them regularly about the debt. Do not leave it to a debt-collection person to call once a month or send a reminder letter.

Only when you have exhausted all available options should you spend the money required to have a solicitor or debt-collection agency collect your bad debts.

Debt recovery can be expensive. The time it takes is a cost you never recover. A major proportion of solicitors’ costs are not recoverable. Debt recovery specialist costs are usually never recovered. Do everything you can to avoid being in the position of having to recover a debt.

Important tips for debt collection

Having customers who are fully aware of how you conduct your business will minimise debt problems.

Here are some points to remember:

• Maintain communication with your customers.
• Follow through on your threats of action.
• Set budgets so that you encourage your staff to collect debts.
• Do not assume that your book-keeper will be a good credit controller because they are two very different roles.

Pricing

• Good credit control starts at the beginning by ensuring that your customer does not become confused with your prices, leading to disputes and non-payment. This includes making your customer aware of the terms and conditions of sale/service.
• Advise your customers of:
• ‘The terms and conditions of sale/service agreement’. This will help you clarify the terms of sale for you and your customer.
• Prices (be upfront about them).
• Do not give your clients nasty surprises. Let them know what they are up for before you do anything or they receive any goods.
• Do not be embarrassed if your product or service costs a lot. Many clients or customers will perceive that they will get better service or a better product if it is more expensive. Do not hold back on discussing money.
• Collect fees in advance.
• One of the easiest ways of avoiding the pain of debt recovery is to avoid selling goods or services on credit. If you insist on payment upfront you will not have any debt recovery problems because there will be no debt.

Payments

Credit policy

You should provide written terms of your credit policy to your customers and have them sign and return this to you as a form of acknowledgement. If you need to commence legal proceedings against them at a later date this will be an important document. ‘The terms and conditions of sale/service agreement’ previously referred to will satisfy this requirement.

You should maintain an individual folder for each credit customer in which you keep all of these documents for ease of reference later on.

Obtain a personal guarantee

If you obtain a personal guarantee from the owners of the business, they will be personally responsible for the payment of the debt owing to you in the event that the business entity does not pay. The fact that there is some personal hurt in there for them should mean that your invoices are paid before other creditors who have not required guarantees.

On a worst-case scenario, you will need to enforce the guarantee against their personal assets, provided of course they have some.

Bill of sale or charge

You may like to consider securing payment for goods and/or services by obtaining a bill of sale or charge. These are all methods used to secure payment by debtors by retaining the right to recover the goods in the event of non-payment.

Deposit or part-payment

You may also consider obtaining a deposit or part-payment of the estimated total invoice before commencing work or delivering goods. By requesting part-payments throughout the provision of these goods and/or services you will dramatically reduce the amount owing to you, and minimise any loss. Should payments not be made, you are in the position to reduce or cease the provision of any more goods and/or services until payments are made. This ensures you maintain control.

Recording customer details

Each customer who wants to trade with you on a credit basis should complete an application for credit. This application form will contain all of the pertinent details to find the customer but should also give you enough information to decide whether you are willing to trade with them on a credit basis.

A worthwhile consideration is checking the customer’s previous trade history. These details should be included in the application form. We recommend you complete a trade references check. This will let you know if they pay their invoices on time and what they are like to deal with on a credit basis.

The more information you have to base your decision on the better informed you will be.

Once you have decided to trade with a customer on a credit basis we recommend you send them the documents covering ‘Credit Approval’, ‘Terms and Conditions of Sale’ and a ‘Guarantee’ document. It is important you get these documents duly signed, witnessed and returned.

Invoicing customers

You need to send an invoice as soon as possible after supplying goods or services. When you do this will depend upon the type of business you have, but there should be no excuse for waiting more than three days before invoicing your customer.

It is important customers are invoiced when they still remember what a good job you did or how good the products were. Every day that passes sees a reduction in the gratitude they feel and therefore less likelihood of prompt payment.

Terms to be outlined on invoice

Your invoice must provide a ‘pay by’ date that can be 7, 14 or 30 days or whatever is usual for your industry. This must not vary from the date that is contained in the ‘Terms and Conditions of Sale/Service Agreement’ and will just be a reminder of when payment is due.

The invoice should also set out the conditions and penalties in relation to the provision of credit and again these should not differ from those contained in the ‘Terms and Conditions of Sale/Service Agreement’.

End-of-month statements

Where possible you should call the debtor after 48 hours to confirm that they have received the goods or services and that there are no problems. You should also establish they have received the invoice if it has been provided to them at this stage. Where payment has not been received and is at the most three days overdue you should then call, visit or send a reminder letter – whichever is appropriate to your industry.

A statement then needs to be sent to the debtor at the end of every month outlining the exact amount outstanding at that stage.

What to do when a payment has not been made

The sooner a bad debt is recognised, the sooner action can be taken and the greater the likelihood of success. If you have maintained contact with the client and the debt hits 60 days outstanding this is when you should take further action. The debt is still fresh at this date. Sixty days may be too long for some industries, so use your discretion on the amount of time to wait.

There are a number of second letters that can be sent to your customer, ranging from gentle to stern.

You should telephone the customer to ascertain the reason for non-payment and what the problem is. It can be easy to ignore a letter but not as easy to ignore somebody on the other end of the telephone.

If the second letter does not secure payment, consider sending a third letter. There are a number of third letters that can be sent to your customer, again ranging from gentle to very stern.

Letters of demand

All letters issued by you should sound like a solicitor wrote them and be in plain English. This letter should be issued before any further action is taken and cost incurred.

A first letter of demand should be sent in an attempt to recover the debt without incurring any legal expenses. It may be necessary for you to ‘give’ a bit in order to have the debt repaid. If the customer is having genuine difficulty repaying the debt, consider allowing them to make instalment payments until the debt is fully repaid. This may mean that the customer only pays a small amount each week but at the least the debt will eventually be repaid.

If the customer is arguing that the goods or service were not ‘up to scratch’ as grounds for non-payment then you may consider reducing the price payable in order to get at least some of the debt paid. Of course this is not ideal, but if you are owed $100 and agree to accept $75 you are only $25 out of pocket, rather than losing the entire $100.

The debtor may be a long-standing customer. Do you stop supplying goods until the debt is repaid? If you do, you risk losing the customer to the opposition. You might consider continuing to supply goods and services to the customer but only on a cash basis until the debt is repaid. This way you are not losing out on future business but you also are not running the risk of more bad debts.

You need to be flexible in the arrangements you are willing to make with a debtor if you want to have the debt repaid and do not want to lose out on future business.

If you reach an agreement with the customer that they can pay the debt in instalments you can use an instalment letter to note this arrangement. Make sure you get them to sign this and return the letter.

If the demand letter does not result in payment of the debt and negotiations on payment have not worked, the next step is to take the appropriate recovery action.

Debt recovery options

• Court action by a claim or minor debt claim.
• Statutory demand on a company – Winding-up proceedings.
• Bankruptcy.

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