Principles and Methods of Collections

Fortunately, most customers pay their bills in the normal course of business. In fact, based on historical data compiled by the Foundation, delinquency generally averages between 7 and 9 days across all industries at any given time. Additionally, delinquency in excess of 91 days for all industries rarely surpasses 2 percent.

Good business requires that collection of invoices be made promptly and without any damage resulting to the customer relationship. It is this latter requirement, namely, to retain the customers’ goodwill, which makes the collection problem a difficult one and which makes skill and tact essential in the handling of collections. Just how much pressure is to be brought to bear to obtain prompt collections and to what extent the relationship may be jeopardized in the effort are questions of policy. The collection problem should be analyzed and the collection policy defined in accordance with such objectives as:

  • the policies of the selling division involved with the problem
  • the economic climate in general
  • the importance of the customer
  • the effect of the combination of dollars and number of customers delinquent on the entire receivables portfolio.

Points to Consider

Our attention is caught by the exceptions, those who do not exhibit the expected pattern of behavior. In evaluating a delinquent customer (or the portfolio of delinquent customers), several factors should be taken into consideration.

  • amount owed–a company can afford to devote more time and effort to the collection of large balances than it can to smaller ones. Two pitfalls to be mindful of in this connection are:
    • the willingness to write-off small balances (which can add up over a year)
    • obstinate, imprudent collection efforts (holding on to the collection for too long).

Either situation can lead to an unprofitable operation, the former through direct credit losses and the latter through a more insidious rise in the costs of recovery. The time to terminate a collection effort is crucial. The decision can make or lose money. Possibly outsourcing of collections based on dollars of exposure should be considered to control collection costs.

  • how long has the item been unpaid–consideration of the age of the item is important. The value of the receivable falls rapidly as a function of time, and the longer the debt has been owed, the less likely you are to be paid.
  • pattern of payment–note whether there have been partial payments or any effort to settle the debt. Has the customer made any sincere effort attempt to take care of the obligation.
  • customer relationship–how long have you been dealing with the customer? If the customer is new, you owe it to them and your company to make your policy on collections clear from the start. Neglecting delinquency at this time is inviting problems forever with the account. If it is an old customer, how has the payment pattern been? How have any delinquencies been cleaned-up in the past? Is there a problem with the product or service?
  • previous dealings with the customer–how has the customer lived up to its commitments in the past. Has the account ever been closed and reopened?

Principles of Collection

Certain principles have been found especially useful in the field of collection and may be grouped into the following areas:

  • collect the money
  • maintain a systematic follow-up
  • get the customer to discuss the account
  • and, preserve goodwill

Collect the money

The primary job of the person responsible for collections is to collect the money as close to the terms of the obligation as possible. There should never be any doubt as to why the individual is engaged in this particular task. The debtor has an obligation to pay within the terms of the agreement. It is the job of the collection person to make sure that this obligation is met. The tone may be indulgent at first, but should be intensified and accelerated as much as necessary to ensure payment by a debtor.

Systematic follow-up

After the initial contact with the delinquent customer, it is important to keep additional contacts on a strict schedule. If the collector, for example, is told that a check will be mailed in a few days, it should be noted. If the check is not received at the promised time, a follow-up is essential, otherwise the collection effort will become ineffective.

Systematic follow-up of accounts, even those which can not pay immediately, reinforces the serious nature of the outstanding debt and emphasizes the importance attached to it by the creditor. That in itself is an important collection advantage.

Discussing the account

Once the collector gets the customer to talk about the delinquent account, the collector is well on the way to receiving payment. That is why emphasis is placed on inviting the debtor to talk. The object of the discussion is to get the debtor’s explanation of the delinquency. It may be a question of a dispute; it may be due to a temporary shortage of funds; or the customer may intend to hold off payment so the creditor’s money can be used in its own business.

During the discussion, the collector may begin to see the debtor’s situation more clearly. If the slow payment is the result of a tempory cash flow problem, tolerence of slower payments may be accepted, but it should be emphasized to the customer that the new schedule of payments must be completed.

Preserve goodwill

Even though the customer may be experiencing some difficulty in meeting payments, it does not preclude them from becoming a good customer in the future. Therefore, it is important to preserve goodwill while pressing for collection. This requires not only tact, but knowledge of the customer and industry. One of the advantages claimed by specialized collection personnel is that they can develop these techniques to their fullest. On the other hand, the team concept presents the opportunity for credit and customer service personnel to better understand the relationship of the customer to the industry and overall marketing objectives of the company.

Methods for Improving Collections

Awareness is the first step in collections–awareness of what is happening in the economy, in your industry, in your own company, and with your customer. The same investigative and analytical techniques which are used for credit approval are valid for the collection process. Unless you have some idea of what your customer’s problems may be and WHY they are paying you slowly (or not paying at all), you may not take the correct first crucial step in collection.

The collection process begins in your own department, and then with other departments in your company, such as shipping, billing, sales, and service. Before contacting the customer, make sure you clear up any internal problems such as:

  • unapplied checks
  • unresolved billing or merchandise disputes
  • unused credits for returns or adjustments
  • any verbal “special terms” given by sales reps

Let’s deal with the questions most inexperienced collectors ask:

  • When do I start collecting?
  • Whom do I contact?
  • How do I say or write it?
  • How often do I follow-up?
  • When should I consider litigation?

When do I start?

Collection really starts with the customer invoice. Make sure your terms are clearly stated so the customer knows exactly when and how much to pay, and where to mail the check (or electronically transfer the funds).

Check to make sure your billings go out promptly, preferably the same day as shipment, and that you have abided by the customer’s request concerning correct billing addresses, duplicate invoices, etc.

When you begin, depends on a number of things–your selling terms, the custom in your industry, your competitive position, and your company’s own financial requirements. Some industries, due to their competitive nature are notorious for not following up for 30-45 days after the due date, thereby extending terms. If your company is dominant in your industry, you stand a better chance of having your customers adhere to your terms than if you are a small company, or new in the market, trying to expand its customer base.

As with a credit policy, collection practices must be flexible. If your company is in the midst of a large promotion requiring customer cooperation, you may want to alter your normal timing until after the promotion is over. Conversely, if your company is in a cash bind, and needs cash more than new sales, you would tighten up. Because collection is one of the least popular things your company does, make sure you keep management informed of what you are doing, and your success rate.

When to start should not be left up to individual collectors, but should be part of a formal credit and collection policy. If you have different product lines with different type customers, and different selling terms, your collection practices should be tailored to those differences.

You should develop some sort of matrix which outlines the timing and type of collection effort.

For example:

Days Delinquent Action
5-10 send statement or first letter, make first phone call
11-20 make second phone call and monitor orders
21-30 third call and follow up letter
31-45 hold orders
46-60 fourth call and final demand letter
over 61 place for collection

As a rule, the longer a customer ages past due, the more frequently you should contact them. Also, at each step, your tone should be more demanding. If your personnel resources are limited, you should choose your larger accounts first, and possibly consider outsourcing the smaller dollar delinquencies from the time the customers become delinquent.

The longer an account is past due, the less your chances are of collecting it. Some studies indicate that you stand a 90% chance of collection within the first 60 days. This drops to 50% over 90 days, 20% over 180 days, and probably nothing over one year.

Many customers pay only after you contact them, believing that if you do not ask them for the money, you really do not care if they pay slowly. After a while they know who pressures them and who does not, so be one of the “early birds” and start your collection process promptly.

If a customer had traditionally paid within your discount terms, and is a large purchaser, do not wait until the net terms expire, contact them after the discount period has expired.

If you have certain large customers whom you know wait for your call before they pay, call them a few days before the payment is due to find out if there are any billing or shipping problems that need to be resolved before they mail their check. This diminishes any excuse they may have to delay payment, and lets them know you have caught on to their delay game.

Who to contact?

You should obtain the name of the individual who has the authority to issue payments when you begin your initial credit investigation. In larger organizations where you do not normally talk to the owner, also obtain the name of the buyer/purchasing agent, and perhaps even the person in charge of the receiving department. The more bases you can cover, the greater your chances are to avoid bureaucratic excuses.

How should you collect–by letter, telephone, fax, in person?

Before you actually write, call or visit, make sure you have at your fingertips, either in hard copy or on your monitor, all the information you will need to make your letter/call/visit complete. These items should include purchase order and/or contract numbers, invoice detail, credit memo detail, unapplied checks, related correspondence, previously disputed open items, statements, and copies of any billing/shipping instructions. If your business routinely provides proofs of delivery for your customers, include these too.

Also review your credit file for recent information about your customer’s paying habits with your organization as well as with the trade. Furthermore, review the customers’ financial condition, and operations. If the file is not updated, this may be a good time to do it. This information may give you clues as to why your customer is not paying you. Also, it will give you the opportunity to ask more incisive questions and tailor your payment request for better results.

In person is probably the best method of collecting, because you are face-to-face with your customer. In addition to hearing what they are saying, you can also watch facial expressions and body language, have an opportunity to look around the premises for any signs of physical deterioration, examine inventory levels, watch customer activity, etc. In some instances, if you know your customer is going to be in your vicinity, invite them to your office to talk about the account, or meet them in a neutral place. A problem with personal visits is that they are expensive. You may want to save them for your largest and most troublesome accounts.

Telephoning is probably your most cost-effective collection method. It’s fast, it gives you the opportunity to listen to what your customer has to say, and yet you are at your own desk with access to all the information you need.

If you are new to collections, ask your supervisor, team leader/coach or an experienced co-worker to do some role playing with you. This is the best way to learn to counter some of the most common excuses why your customer cannot pay, such as:

  • The product was defective, missing, mispriced, returned
  • The check is in the mail
  • The bookkeeper is on vacation
  • The system is down

Always observe good telephone manners. It’s OK to be understanding of a customer’s problems, but do not be sidetracked by small talk or taken in by “hard-luck” stories.

When you are dealing with a delinquent customer, expect some emotion from them. Infrequently, a customer will become agitated and abusive. Even though it’s difficult, remain calm and businesslike, let your customer blow off steam, and then resume the conversation when they are calm. If this does not work, and particularly if they become abusive, tell them politely that you are terminating the conversation, and hang up. After you calm down, try again. Most of the time, the second call is more productive, and many times the customer will offer an apology. Accept it, and go on with your business.

  • Before making your payment request, decide what your fallback position is.
  • Even though you should always ask for full payment immediately, you know that in some instances you may not get it.
  • Know the timing and minimum dollar amount that you will accept.
  • If you do not have the authority to make concessions, discuss the matter with someone in charge, and agree on how far you can extend your offer.
  • However, do not let your intent be known to the customer.
  • Keep this as a negotiating tool.

In some instances you will better protect your interests by agreeing to a payout, rather than insisting on a full payment immediately. You never know if your request will be the one to push your account over the edge to bankruptcy.

How often to follow-up?

If your customer makes a commitment, note the date and amount on a calendar, and follow up with them if the check does not arrive. This is important. If you do not do it, your customer may think you really do not care, and may delay even longer.

In structuring payouts over time, keep the length of total time as short as possible, and opt for weekly rather than every two weeks or monthly payments. You should always confirm any payout plan in writing, and use actual dates and amounts of the payments. Send two copies of your confirming letter to the customer along with a prepaid addressed envelope. Ask them to sign a copy of the letter, acknowledging that they understand and agree to your plan, and return it to you. In any confirming letter, you should state that if the customer does not adhere to the agreement, the entire amount is immediately payable in full.

Although it’s not possible in every case, try to keep merchandise (or service) flowing to the customer during your collection process. Your ability to continue to support the customer and at what volume level, should be based on the gross margin return your company earns on the sale. This action may be defined in your credit and collection policy. In some cases you may have to withhold shipments, but remember that by doing this, you have cut off part of your relationship. The customer may need your goods to raise cash to pay for the unpaid merchandise. By spoon-feeding the financially troubled customer, you may get “stuck” on the last payment, but in-the-meantime, you have moved inventory which is part of your responsibility to your company.

If the customer cannot get your product elsewhere, you are in a good position, but if they have alternate sources of supply, you have lost some of your leverage. In any plan where you continue to ship, structure the payments so they exceed the value of the shipments in order to bring the entire past due balance down to zero at the end of the payout period. You can do this with a restructured series of payments, or by tying each order into a payment; i.e., sending a $500 check with every $250 order.

Regardless of how you have contacted the customer, here are some other points to consider:

  • In some cases, you may ask the customer to send a series of post-dated checks. While this does not guarantee they will all clear the bank, at least you control the mailing and deposit, and you do not have to rely on the customer to do it.
  • If your payout plan includes taking any guarantees or security, make sure your legal department or representative reviews any formal agreements before they are finalized.
  • During any payout arrangement where you are continuing to ship goods, be prepared to stop if:
    • payments are not made as agreed
    • NSF checks are received by you or others
    • you learn other creditors have placed the account for collection or started legal action
    • a bank has called its loan

When Should Litigation Be Considered?

Never threaten a customer in writing or orally that their credit reputation will be ruined if they do not pay you. In the first place, you are not telling them something they do not already know, and secondly, you could be sued. Also, do not threaten legal action unless you are fully prepared to follow through, and have received the necessary approval from your management.

Always keep your sales and distribution people informed about your collection efforts, especially those that are under credit restriction. This will avoid them working at cross purposes by soliciting or shipping orders. Also, in certain instances your sales reps may be able to assist in the collection effort. Make sure you check with management before you attempt this.

Using letters is another option for collecting. These can be useful for confirmation of telephone agreements, or may be used in mass mailings if you have the ability to automate the process.

Consider these points if you use letters:

  • address them to a specific individual rather than to a title
  • they should be short and to the point, avoid overused, trite and meaningless expressions
  • be serious and firm, just ask for what you want
  • write as though you were speaking to the customer

On final demand letters where you tell the customer that the next step is litigation, try to send the letter by an overnight carrier such as FedEx, Airborne or UPS where the customer must sign for it. This also indicates your sense of urgency. Using certified US Mail is another option, but many customers suspect that they are collection letters, and do not accept them. Sometimes using a plain envelope with no return address on it, but containing your letterhead may be helpful.

Faxing is a quick way to send a collection notice, but it lacks confidentiality in that you never know who at the customer’s end will actually see it. If you do FAX, address it to a specific individual, and call that person first, asking them to be on the lookout for it. Faxing can be useful for sending the documents the customer may need to pay, such as invoice copies, proofs of delivery, lists of open invoices, etc.

When you should start legal action cannot be answered by any specific time frame. If your customer has not ordered from you, sent a payment, answered a letter, or returned a phone call for at least three weeks, in spite of all your efforts, call some other suppliers and find out what they may know. If there seems to be a pattern, then it’s probably time to place the account with a collection agency or attorney.

As a final note, if and when the customer files for protection under the bankruptcy laws, you must stop all collection activities against the debtor. Contact your legal representative for further information on this matter.

Our Platinum Partners