Accounts receivable management: 5 reasons why customers pay late and what to do in each case
Effective accounts receivable management is critical. In fact, it is what makes or breaks a business.
Small businesses however, especially those without sophisticated credit departments, have a hard time getting paid by their customers. The two co-founders of Funding Gates, Jean-Marc Freuler and Ismail Colak, provide their expert insights to millions of U.S. small businesses on what to do when customers don’t pay.
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Most of the time, your late-paying customers fall into one of the five categories we describe below. Your delinquent accounts will usually have customers from ALL of these categories. You should therefore know how to identify each customer's category, know the reasons and figure out how to act accordingly. Here's a basic guide:
1. INDUSTRY-WIDE PAYMENT PRACTICES
Reasons: Some businesses pay late because of their sales, receivables and inventory cycles, or operational practices that are customary in their industry. Some industries are infamous for the notorious delinquency rates (such as construction and building supplies, manufacturing, wholesale distribution).
What you can do: Having a corporate credit policy usually helps. Signal your customers that your practice does not allow for average industry cycles. The fact that many businesses are not able to collect from customers does not necessarily mean you should give up on your receivables. Your customers need to know that you have robust credit policies in place. You need to follow-up regularly on late invoices. You need to help them with their payments (giving them the option to pay in installments, for example). The point is, if you do what everyone else is doing in your industry, your delinquency rates will be just like everyone else's. If you improve your credit practices, however, your customers will respond to your calls & payment requests.
2. CUSTOMERS WITH OTHER, CRITICAL SUPPLIERS
Reasons: You may not be ranked at the top of your customer's payment priority list. Your product may not be critical to your customers' business cycle, or your product may be easily replaced by products from other suppliers. Another important reason may be that your customer has other suppliers that have more stringent credit criteria. So, your customer pays them before paying you.
What you can do: The fact that they have other suppliers cannot be an excuse for them not to pay you. You need to have a firmer stand from the beginning. Have a clearly defined process for your accounts. There are many ways you can ask for the payment you deserve while still being cordial. Your customers need to know that it is as important for your business to get paid as it is for your customers' business. But we live in a distracted world, and getting your customers' attention like all the other suppliers is critical in the race to get paid. Always remember: the squeaky wheel gets the grease.
3. CUSTOMERS WHO ARE IN FINANCIAL DIFFICULTY
Reasons: The reasons for this can be anything. Your customer's business may be going through tough times and they really are unable to pay you back. This category carries by far the highest risk for your receivables. Today, overall business bankruptcy rates are lower than 2009 levels, however the failure rate is still quite high in several industries.
What you can do: To avoid facing such a challenging situation, you need to constantly monitor your customer portfolio to see if there are any changes on your customers' credit profiles. You can have an idea who is not doing well by simply looking at your customers' court records such as judgments, liens, suits, UCC filings and bankruptcies. As soon as you know one of your customers is in financial difficulty, you should take action. Adjust the credit limits based on the information you have. If you sold something and waiting to get paid, hurry up and get in front of the line. Because if you don't act quickly, you may never see that customer again.
4. CUSTOMERS WHO CAN'T TRACK THEIR PAYABLES
Reasons: Your customer's internal accounting practices may be a mess. A disorganized accounting department or a lack of headcount that knows how to track and process payables may cause delayed payments, not only to you but to everyone dealing with that business. This is a typical scenario for new companies and startups that don't have the systems in place.
What you can do: This customer requires more attention than others. You may need to follow-up regularly and remind your customer that they have an upcoming payment. Systematic reminders before and after the due date should become part of a standard operating procedure for this type of client. Depending on your relationship, if e-mails, faxes and letters are not powerful enough to get paid, you may have to try more severe methods and capture the attention of anyone in the company who is in a position to pay you.
5. CUSTOMERS WHO KNOW THEY CAN GET AWAY WITH IT
If a substantial part of your accounts falls into this category, you'd better do something to change that.
Reasons: It is the way you deal with your customers. If you have traditionally been tolerant towards the late-payers, your customers already know that there are very little repercussions to paying you late. In that case, it is obviously in their best interest to stretch the payments as much as possible. After all, it is basically free cash. The later they pay, the more working capital they will keep for their business.
What you can do: Standardize your credit policies. Set up clearly defined credit procedures for all your customers. Be firm on your deadlines and your follow-up practices. Collect more information, always monitor your customers, let the world know that you will follow-up on late accounts, precisely because it is your money. "Being predictable" is very important in credit. All your customers should know when they will be getting a call or a letter from you if they don't pay you. Predictability will lead to credibility. Credibility will help you get paid earlier than you otherwise would.
Always remember that a few basic changes in your receivables management practices can create wonders for your business.
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