MANAGING TRADE DEBTORS
It’s a sad fact that over 60% of small businesses in Australia fail within the first three years of opening their doors. What is even sadder about this is that many of these businesses didn’t fail because they had a terrible idea to start with (though some did!), but rather they failed because of poor cash management. The had insufficient working capital (i.e. cash) to deliver on their plans and went under as a result. All the more sad because it didn’t need to be this way.
We’ve written before about ways to better manage the cash in your business, and of course you could seek funding to increase the working capital in your business, but one of the easiest (and cheapest!) ways you can improve your cash flow is to simply manage your trade debtors more effectively.
Trade debtors are your clients and customers that you’ve issued an invoice to, but haven’t yet paid up.
You might think that it’s okay because all of your clients eventually pay your invoices so you don’t want to change what you’re currently doing (or not doing as the case may be). Pretty common story, but indulge me for a moment. Let’s say you’re operating on 30 day terms with your clients and you invoice in arrears (i.e. when the job is complete) and your clients pay, on average, 60 days after the due date (recent studies show that average debtor days in Australia is over 50 days) and the project took two months to complete. You’ve effectively given this client a 150+ day interest free loan. Now, consider that the costs associated with delivering this work were paid months ago without any income to cover them and you can see why this isn’t the best way to run your business. Current bank overdraft interest rates are around 6.5% so if this invoice was for a $40,000 website this late-paying client has just cost you over $1,000.
The downsides to late-paying clients are numerous:
- The later an invoice becomes the more likely it is that it will never be paid
- Client relationships become strained
- Cashflow becomes unmanageable
- Capital is tied up giving interest free loans and not being invested back into the business for growth
Once you take all of these factors into account you can see why businesses might fail off the back of not being paid on time. Fortunately, it doesn’t need to all be gloom and doom as a well designed debtor management procedure is easy to implement and should start to deliver results almost immediately. What follows is our best practice guide to debtor management and it’s broken down into three key areas.
Once your service proposal has been accepted and you’re in the exciting honeymoon period of your professional relationship it’s important to introduce the business equivalent of the pre-nup – the services agreement (aka the engagement letter). This should happen before any real work starts.
This agreement should outline what services your business will provide, to whom they are being provided, the agreed fees, payment terms, etc. They set expectations right up front so there are no surprises from either side – because nobody likes surprises. Explain in your agreement when you expect to issue your invoices, whether that might be upfront, as progress invoices, or maybe upon completion. The agreement should also stipulate that you reserve the right to charge for work requested that is outside of the scope of the original price (e.g. you’ve quoted to build their profile in print media, not manage their social media accounts) and it should outline your expectation that if invoices are unpaid you won’t be undertaking any further work. It’s a good idea to walk your client through the agreement as many people have a tendency to just sign things emailed to them without really understanding them.
The agreement should be signed by both parties and filed away for safe-keeping before the job starts. There are templates for these agreements floating around the internet, but our advice would be to have your lawyer draft something simple for you to use as a template for all your ongoing work.
Send the invoice, get paid. Sounds simple enough, but the crazy truth is that often people have trouble with debtors because they simply aren’t sending invoices for their work (we see this all the time). Issue invoices regularly throughout the job and stop work if invoices are unpaid and overdue. Here are some good pointers for issuing invoices:
- Make sure the invoice is clear and easy to read and understand – from who, for what, how much?
- Include as many payment options as possible so there are no excuses for non-payment.
- Send the invoice to the right person – ask upfront who the invoices should be sent to.
- Don’t send the invoices included with other work or documents or else they might get lost. Always send them separately and you can try sending them from a different email address (e.g. accounts@) to ensure don’t get confused for anything else. Your job management and/or accounting platform should be able to help here.
Clients who don’t pay
Unpaid invoices are the bane of any business owner’s life and whilst it isn’t possible to avoid them altogether, there are some strategies you can employ to minimise the risk of late payment or non-payment of your invoices. Consistency is key here, make sure the procedure is always followed.
- First, put yourself in your client’s shoes. Did you make it clear about what the fees would be and when they would be payable? Have you issued sufficient reminders and notice to get the invoice paid? Are you offering a variety of payment methods? Have you delivered what you said you would deliver? Before setting the dogs on a client, check first to make sure the fault isn’t yours.
- Next, send reminders. Remembering to send these can be time-consuming, boring, and dangerous for client relations as it’s easy to get wrong and receiving an undeserved overdue payment reminder can be upsetting for a client. Save yourself the hassle and set up an automated reminder service that plugs into your existing invoicing/accounting software. There are a few options out there that offer a low-cost, low-hassle solution which are quite effective at automating the reminder process.
- Once an invoice is past a certain point you’ll need to escalate the issue so the non-payer realises you’re serious about collecting the money. After a few email reminders it’s time to call. Remember to tread lightly, simply call to see if you’ve done something wrong or if there is some other explanation for the unpaid invoice. If no amount of reminders or calls will get you paid it may be time to lodge a statement of claim with the local court or engage a debt collection company or a lawyer. Debt collection companies usually just take over the job of emailing/calling/mailing the debtor and typically only have more luck that the owner because the debtor realises the severity of the situation. Lawyers can be very effective, but very expensive, always take this path with caution!
Use software to automatically chase up invoices that are one week overdue, two weeks, three weeks, then start making calls. Following that you can consider sending a letter of demand typically at the three month point then involve lawyers after that assuming you can’t just take it to the small claims court. Once burnt you should insist on payment upfront if you are going to continue working with the client.
Put what you’ve read here into practice! Key with this is consistency, so make sure your whole team understands the new system and make sure everyone is following the procedure in full every time. Debtor management falls over when people start colouring outside the lines, so make this part of your regular finance meetings to ensure the system is doing the job you need it to.
If you’d like help implementing a debtor management system, or with anything else in your business, get in touch today. We’d love to help. Our virtual CFO service allows business owners to relax about their financials, provides expert-level advice on tap and saves on wages by not having to hire a CFO internally.