Delinquent Accounts

When it comes to accounts receivable, 45 is the new 30. Late payments are not a new problem, but the weakening economy has made matters worse. Today, customers stretch payments well beyond the conventional term of Net 30, routinely paying at Net 45, 60, even 120, and non-payments are more common than ever.

“I remember the days when guys would discount if a customer paid in five or 10 days,” says Hank Josephs, president of Spruce Industries Inc. in Garwood, N.J. “No one does that anymore. In our marketplace, if you have a customer who pays in 45 days, that’s a pretty good account. Money is tighter and housekeeping is one of the areas where they think they can cut or delay payments.”

Problem payers can be a major headache for distributors. When cash flow is interrupted, a distributor may be forced to pay its own vendors late. Depending on the size of the business, it may need to get a bank loan to cover payments that can’t be delayed, such as payroll and rent.

“It has a snowball effect,” says Linda King, president of Dee Janitorial in Chicago. “It jams me up because I owe people money too. My vendors are being paid late and then they are paying their suppliers late.”

Far worse, however, is when a customer doesn’t pay at all. Then a distributor may be forced to sue or take a loss. Memphis Chemical & Janitorial Supply Co. in Memphis, Tenn., found itself in this unenviable situation a few years after it opened in 2002.

The problem started when Memphis Chemical extended credit to a company without performing a background check and without establishing a credit limit. The customer quickly racked up a sizable past-due balance of more than 120 days. With the writing on the wall, the distributor sued, but it was too little, too late. The customer filed for bankruptcy and Memphis Chemical lost nearly $35,000.

“That was the blow for us to put policies in place and draw lines in the sand,” says Hank Brown, Memphis Chemical’s vice president of operations. “We’ve learned from our mistakes but I hope that others don’t have to have a $35,000 lesson to wake up and do something about it.”

While any company that offers credit can expect to experience problems with accounts-receivable, there are ways to manage the situation and lessen the damage.

Start Smart

The first and most important thing Memphis Chemical did after its big financial loss was create a credit committee. The group of four meets monthly to decide whether to extend credit to new and existing customers and, if so, how much. They base their decisions on credit histories, business references and gut feelings.

“Putting your heads together on the front end can help you weed out accounts that are not going to pay or those that will be slow payers,” Brown says.

If distributors don’t already have one, they should create a credit application and use it. Call the prospective customer’s other vendors and ask whether the client’s terms have changed, which typically indicates a poor payment history. Also ask for bank account numbers; check the balances and look for a history of bounced checks.

“The best customers are usually the ones that are willing to give you their bank account number so you can check their history,” says Andy Brahms, owner of Armchem International Corp. in Fort Lauderdale, Fla. “If they are transparent, they have nothing to hide.”

Applicants with shaky credit history don’t have to be turned away. To reduce liability, however, they should be given reduced lines of credit or be allowed to pay only with cash or credit card.

“Usually we will start accounts off with a low credit limit where in the event it has to be written off or there’s no payment, we’re not devastated by it,” Brown says. “That’s something early on we failed to do.”

Review accounts regularly. An account that merited a large credit limit at the start may not always deserve it. Memphis Chemical’s credit committee also regularly reviews its accounts to determine whether there are red flags that warrant lowering a credit limit.

Let customers know credit policies from the beginning. Tell them at what point late payments result in a frozen account, collections or a lawsuit. Let them know how many late payments it takes before credit limits are lowered, cash on delivery (COD) is implemented, or a relationship is terminated. Distributors should also inform customers if they operate on a tiered system that rewards prompt payers with better pricing.

“Having my salesman discuss the terms early in the relationship development is helpful,” Josephs says. “The sooner you can discuss the issue, the better.”

Collect With Care

Some customers pay based on invoices while others pay multiple invoices when they receive the monthly statement. Distributors should cover their bases by sending invoices immediately as each order is placed as well as monthly or bi-weekly statements.

It isn’t enough to send out bills and assume they will be paid. Consistently review accounts receivable to stay ahead of the eight ball. For example, at Memphis Chemical’s weekly management meeting, everyone reviews a status sheet to look for — and immediately address — late payments.

“We keep it in front of us and look at it weekly — and some of us look at it daily — just to be aware of what’s going on,” Brown says.

Awareness is the key to getting paid. The companies with the fewest late payment problems are typically those that implement a formal collections system and then monitor it with zeal.

“If you just left it up to everyone to pay based on the honor system, most people would take advantage of it,” Brahms says. “You have to have systems in place to get paid. Businesses need to be efficient on all cylinders, not just sales.”

When the monitoring system turns up a late payment, start the collections process with a reminder letter on Day 31. If that doesn’t work, make a friendly phone call around Day 40 or 45.

“You have to be very persistent to get your money without trying to upset your customer if you still want to do business with them,” Dee Janitorial’s King says. “Making phone calls has always worked well for us and we can usually collect our money. If you are nasty and abrupt with people, you will get nowhere.”

At Day 60, follow-up with another, sterner phone call and ask the customer to prepare a check for the salesperson to pick up. Getting the sales staff involved at 60 to 90 days can be an effective last-ditch effort to collect.

“When they know it will affect their commission, it tends to trigger a little bit more action,” Josephs says.

At 90 days, Spruce Industries puts the customer on hold. Freezing an account — or threatening to do so — usually results in a payment.

The Final Countdown

When it becomes clear that a customer has no intention of paying, it’s time to get serious. For most distributors, that tipping point comes at 120 days. That’s when Memphis Chemical hands the account over to its attorney, who sends a series of threatening letters.

“Say we give her 15 accounts, the letter usually grabs the attention of 10 of them and we’d get paid for those,” Brown says.

Armchem International Corp. uses a collection agency to deal with accounts that are significantly late. The agency first sends out a series of three letters before handing off the account to its internal legal department, which sues the delinquent customer. If the agency collects, it splits the judgment with Armchem evenly.

“Most people respond because they don’t want a bad credit rating and the collections agency will definitely report these accounts to the credit agencies and they get a debit against their record,” Brahms says.

Because of their high fees, collection agencies are particularly good for dealing with small debts. Filing a small-claims court case can easily cost several hundred dollars in fees and time spent (and more if distributors have to garnish an account), which may merit the expense of hiring an agency to do the work instead.

For larger sums, self-representation in court can be worthwhile. When a cleaning contractor stopped paying Dee Janitorial (after avoiding phone calls and bouncing a check), King made a trip to small-claims court.

“He owed me a couple grand,” King says. “The judge granted me a stop on his bank account so I was able to get my money. It was worth it, but if it had been $500 it wouldn’t have been worth going after and I would have written it off.”

Taking a loss on small debts is an unfortunate cost of doing business. For the 20 to 30 percent of accounts that don’t respond to letters from the lawyer, Memphis Chemical sues only those that are cost-effective — the rest are written off on taxes as a bad debt. Likewise, Armchem writes off any debt that is sent to the collection agency; if the company collects, it re-books the income. Write-offs may be necessary, but they are never taken lightly.

“When you write something off you have to sell a lot more to overcome that,” Josephs says. “If it’s a big loss, you have to sell a lot a high-profit items to overcome it. That will cause some sleepless nights.”

The only thing harder than writing off a bad debt is writing off a customer. When it comes to late payers, however, the time may come when a distributor has to say “good-bye.” Every distributor must draw its own line between acceptable tardiness and unforgivable behavior.

“Once we call an attorney, that customer is as good as gone. When we involve an attorney, it’s costing me money,” Josephs says. “We never fire an account, they fire themselves. But it can be difficult to decide when a customer is no longer a good customer. If you put them on COD, they can go somewhere else. There’s always going to be another guy who is willing to take a risk.”

Becky Mollenkamp is a freelance writer based in Des Moines, Iowa. She is a frequent contributor to Sanitary Maintenance.