Manage Your Receivables like a Rock Star – Part 1: Set-Up

Posted by Heather Villa, CMA, MBA, MSM on September 28, 2010 in: Bookkeeping & Accounting, Tips in 10

Extending credit to your customers can be good for business. Without the opportunity to “buy now and pay later”, you’ll need to run a business where you require payment up-front in order to complete the transaction. That might work for some businesses but not for all businesses. And chances are, it may not work for you.

There could be any number of reasons why we have to extend some form of credit to our clients: Perhaps all of your competition is doing it and if you didn’t, you’d be out of business; perhaps you are a freelancer who requires payment when the project is complete and not before; perhaps the customer cuts a check on a certain day of the month; perhaps you offer a service in which you collect a fee at the end of the month for usage; perhaps you’re a consultant who collects payment based on the ROI you deliver (and thus need to wait for it to be measured first); perhaps you delivered your product or service and the customer realized that they simply couldn’t pay it all right now… I could go on and on.

Whatever the reason, in most cases, giving customers the option to buy now and pay later comes with the territory. As soon as you extend credit and your customer owes you money, you step into the world of receivables. For many business owners (especially the new ones) this is an uncomfortable place to be. You don’t want to have to send reminders. You don’t want to have to make collection calls. You NEVER want it to get to the point where a customer simply doesn’t pay and walks away with your product or service. As a business owner, it’s easy to take that personally because you pay all of your bills and you treat people fairly and put your heart and soul into the business, so when someone who takes your product or service without paying, it FEELS no different than if someone stole from you.

And yet, you can’t escape it: You need to offer credit. So, what can you do to manage the situation, to avoid people from becoming “deadbeat” clients, and to collect the money that is rightfully owed to you?

The good news is, the work doesn’t have to be as unpleasant as it seems. And it doesn’t have to take as long as it seems, either. In just ten minutes a day you can manage your receivables, and because you are managing them you’ll be more likely to collect more money owed to you.

Get Started

Before you can manage your receivables effectively in 10 minutes a day, you’ll need to have a couple of systems in place first. Set these up and the 10 minutes a day will be time well spent. Setting up these processes might take a week of 10 minutes a day just to work through on their own. That’s okay. These are extremely valuable systems to have in place and they will put you in a good position over the long run to minimize bad debt and maximize the credit you collect.

First, you need to have a list of money owed. Some like a paper list, printed off regularly; others like an Excel spreadsheet; others have a bookkeeping system or invoicing service that will generate a list for them. Pick whatever works for you but at the very least you’ll need a list of people who owe you money, no matter how old that money is, and it would be nice to have it sorted by date. If it’s electronic, it will be refreshed constantly. If it’s in paper format, print off a new list each week. This is your receivables list and you’ll use it when you read the next Tips In Ten issue. So, take ten minutes and get the list and put it in order.

Second, you need to know what your average operating expenses are and how your income is split between immediate payment and receivables. Figure out the maximum amount of credit you are comfortable giving out in a month. This is your monthly risk threshold number. Divide this number by the average amount of credit you give to each customer and that will tell you how many customers you can give credit to. For example, if you determine that you don’t want to give out more than $5,000 worth of credit in a month, and customers are granted an average of $500 credit, then you can’t have more than 10 customers at a time on credit. If you want to give credit to more customers than that number, you’ll need to start collecting a security deposit from each one. By figuring these numbers out, you will avoid over-extending the credit you provide and that will help you to avoid scrambling to cover your operations with loans and credit cards while you get customers to pay. Many businesses fail in their first two years, not always because of a lack of customers, but many times because they over-extend the amount of credit they give and then don’t have enough money to cover operating expenses. Take 10 minutes one day (or over a couple days if you need to) and make sure you know these numbers. As long as there is cash flow, from old receivables being paid and from customers who pay cash, you can extend some credit but you need to find the balance for your business.

Third, put good processes in place including a consistent invoicing process, some payment terms, and a credit approval process. Obviously you don’t want to make it impossible for people to buy from you, but here’s what I would suggest:

  • You should have your terms already set out. Know what they are and don’t shoot from the hip. And, if you have to extend a lot of credit, offer incentives to people who pay early or who pay on time or who pay within a certain period. This is much easier and way more positive than charging interest on late payments (although you might have to do that, too, and that’s okay).
  • The more someone buys from you, the more information you should expect from them. Verify their phone numbers and email addresses.
  • Do some research about them online, if appropriate. Do they have a web presence? Even something simple like seeing how many followers they have on Twitter, how many connections they have on LinkedIn and how many blog posts they have in their blog won’t mitigate every receivable issue but it will help you to know how long they’ve been around and how easy it is to get in touch with them.
  • Create thresholds of amounts owing and connect those with payments you expect from them. For example, if you’re going to give someone $1000 credit, require a minimum payment of $250. A security deposit, for example, might be the right choice for your business. And the more credit they need, the more security deposit you require.
  • I don’t need to tell you that you shouldn’t extend credit to everyone every time they ask. For example, if someone doesn’t pay one bill for a long time, then pays it and expects credit again – they shouldn’t get credit. Or another example: A brand spanking new client from a business you’ve never heard of before, who approaches you with a huge order and demands full credit. – that’s a no-go in my books.

This might seem like it will take more than 10 minutes but you probably already have some of this in place, it just needs to be formalized.

Lastly, managing your receivables actually starts long before you deliver your product or service, and even before the customer contracts your services. It starts with a relationship. Build one. You don’t have to be best friends with your clients but you should try to connect with them, empathize with them, and be friendly with them. It’s good for all aspects of your business. It helps them to be more loyal, it helps you to understand them better when you need to sell them something, and it helps to diminish the likelihood that they will not pay. On the occasions in which I’ve had non-paying clients, of the ones with whom I never had a relationship, I know that income is gone; but of the ones with whom I’ve had a relationship, I’ve actually had “troublesome” clients call me back a year and a half later and pay me based solely on the foundation of my earlier relationship with them.

When you have these things in place, you’re ready to manage your receivables in ten minutes a day. That’s what I’ll cover in the next Tips In Ten article.

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