The Best Way to Collect Unpaid Invoices

Summary: Collecting unpaid invoices is probably one of the most tedious tasks of running a business. However, it’s also the most important one. Getting paid on time is vital to the success of a company. It brings in the money to pay employees, suppliers, rent, and yourself. Consequently, it’s essential to handle collections well from the start.

Fortunately, most collections problems have a simple solution. It’s a matter of following the right system. This article shares a collections system that is easy to implement, simple, efficient, and incredibly effective. You will learn how to:

  1. Avoid bad-paying clients
  2. Do collections calls the right way
  3. Use a simple trick to reduce the number of disputes
  4. Improve cash flow without financing
  5. Use the right financing to fix problems

How to get paid on time

Getting paid on time is not as complicated as most business owners think. It starts by giving net-30 to net 60-day terms only to clients who have a track record of always paying in time. Fortunately, finding a client’s payment record is relatively easy and can be done online. Additionally, you need a good invoicing and collections process. Once you have this in place, you will be collecting your accounts receivable with minimal hassle.

There is one important question left. What happens if a potential client does not have a good payment track record? You can work with them as long as they pay in advance or upon delivery. However, you should not give them net-30 days credit. Otherwise, you could see those invoices quickly turn into bad debt.

Step #1: Check your customer’s payment history

The most effective way to determine if a client is a good payer is to check their payment history with other suppliers. A company that pays its other suppliers on time will likely pay you on time as well. You can quickly check a company’s payment track record using a commercial credit report.

Commercial credit reports are available online and provide varying levels of detail about your client’s financial health. Simple reports provide a credit score and an average Days Sales Outstanding (DSO), which is how long invoices take to pay. More complex reports may list other vendors and provide detailed trade line information.

If a client has a good track record paying other vendors, they will likely pay you on time as well. Therefore, you can feel comfortable giving them a reasonable amount of credit. Commercial credit reports are relatively inexpensive and can be bought from companies such as Ansonia, Dun & Bradstreet, and Experian. These reports are easy to understand and often provide a suggested credit line.

Just doing this single step will likely improve your collections and cash flow. However, there are other steps that you should also implement.

Step #2: Use a well-written contract

A contract should govern every commercial sale. A contract is essential if you provide your clients with 30 to 60 days to pay their invoices. The agreement must be drafted by an attorney and outline all deliverables, time frames, how disputes are handled, and all payment expectations.

Not using a contract is usually a costly mistake, especially if you are offering payment terms. You will have nothing in writing that outlines when payment is due. Consequently, you will have little recourse if you need to take legal action.

Step #3: Use a delivery acceptance letter

Many small businesses make the mistake of never getting any proof from the client that the work or product was received and accepted. This oversight can leave you exposed to collections problems down the road. In our experience, you can improve your collections process by using an acceptance letter. The letter states the client is satisfied with work that has been done or products that have been delivered. The client should sign it once the work is completed.

Using an acceptance letter has several benefits. First and foremost, it helps you identify potential issues at the time of delivery. If the client is unwilling to sign the letter, there is obviously a problem. This step gives you a chance to fix the problem immediately and minimizes the chances of having a dispute later on.

The acceptance letter can also be used to speed up collections, as we will see in the next section. Lastly, the acceptance letter serves as documentation that the client accepted your work/product, should you ever need to take legal action. We suggest that you have an attorney draft a simple letter. However, don’t make it too onerous, or your client may be unwilling to sign it.

Step #4: Send the invoice and paperwork promptly

Send an invoice and any related paperwork as soon as the work is completed or the product is delivered. Include the acceptance letter from Step #3, as it helps prove that you performed what was stipulated in the contract. Follow the payment procedure outlined in the contract. If your client requires that you send the invoices to accounts payable, with a copy to the project manager (or someone else), do so.

We have seen clients have their payments delayed because they did not follow the payments clause of the client’s contract. This scenario is common when dealing with large companies.

Step #5: Follow up with clients regularly

If you have followed these steps so far, most payments should arrive within your contract terms. In principle, you should not have many (or any) collections problems. However, it’s still a good idea to follow up with clients regularly. It helps keep their payments running like clockwork. On the day you send the invoice, verify that your client got it, along with all the paperwork. This step ensures that the invoice has been received and will be processed.

Once the invoice is five days past due (i.e., on day 35 of a net-30 invoice), call or email the client to see if there are any issues. If there are no issues, try to secure a new payment date. If this new payment date is missed again, wait a few days and repeat this process. Unfortunately, if the client misses multiple payment dates, you may have a collections problem.

The most important point about client conversations is to always treat clients with courtesy and professionalism. Never break this rule, even if the client is not paying you and is not behaving professionally. You will have better luck collecting slow-paying invoices by remaining professional.

Step #6: Handle disputes professionally

If your clients have good commercial credit, most missed payments will be due to a dispute. In our experience, there are two types of disputes: genuine and “manufactured.”

In a genuine dispute, the client is truly unhappy with the quality of your product or service. If your client has a genuine dispute, do your best to solve the issue promptly. Do so even if they signed the delivery acceptance letter. This approach helps you keep the client and your reputation.

Unfortunately, some less ethical clients may “manufacture” disputes hoping to get additional free work or products. Basically, there is no dispute, per se. Instead, the dispute is an underhanded tactic to hold your payment hostage until they get some free work. Fortunately, most credit checks will root out this type of client, but this problem still happens sometimes. In this case, send your client a copy of the signed acceptance letter. Calmly explain that your work was concluded, and they accepted it. Usually, this tactic defuses the problem. It’s hard for them to argue that they are unhappy with your work if it meets their contract requirements and if you have a signed letter stating they accepted the work.

As stated in the previous step, always behave with courtesy and professionalism – even if the dispute is “manufactured.”

Step #7: Know when to use outside help

No invoicing and collections method is 100% perfect. There is a small chance some clients will not pay their invoices. Non-payment can happen due to unforeseen events, such as client bankruptcies or changes in the economy. In this case, consider hiring an attorney or working with a collections agency. Dealing with past due invoices and collections problems distracts you from running your business and can affect morale. It’s best to let professionals handle it.

How to improve cash flow without financing?

Having a good collections process helps ensure clients pay within terms. However, sometimes you want clients to pay even sooner. This desire is common for companies that are growing quickly. A great way to accelerate revenues is to provide early payment discounts.

The discount acts as an incentive and is often enough to persuade some clients to pay quickly. Most companies offer clients a 2% discount if they pay within ten days of getting the invoice. However, the terms are negotiable.

Be careful about offering this incentive to companies with questionable credit. It may lead to companies paying late but taking the discount. This outcome worsens cash flow and reduces your profit margins

How to use financing to improve cash flow

Early payment discounts can work well, but they have a significant limitation. Early payments are voluntary, and clients can choose not to make them. Furthermore, you never know which clients will select this option. Ultimately, you never know if a client will pay early or 30 to 60 days later

If you need predictable cash flow, consider using financing. The most cost-effective solution to finance your company is a business line of credit. While they are flexible and relatively cheap, it’s harder to qualify for a line of credit. Most lenders provide lines of credit only to clients with impeccable financial statements.

Cash flow alternatives for small and midsize businesses

Small businesses that cannot qualify for a line of credit should consider invoice factoring or asset-based lending (ABL). Both solutions improve your cash flow, but ABLs are better suited for midsize companies. These solutions are useful if:

  1. Your clients are good payers – and –
  2. You can’t afford to wait up to 60 days for a payment

a) Invoice factoring

Factoring allows you to finance slow-paying invoices from creditworthy clients. Factoring companies can advance up to 90% of the invoice value as soon as you submit it to your client. This advance gives you the funds to operate your business and grow. Your company gets the remaining 10%, less a small fee, once your client pays in full on their regular schedule. Qualifying for factoring is relatively easy, and lines can be deployed in a week or so. To learn more about this solution, read “What is factoring?” and “How does factoring work?

b) Asset-based loans

Asset-based loans enable you to finance different business assets, such as accounts receivable, machinery, and inventory. This option is available to companies that invoice about a million (or more) dollars per month. Many companies use ABLs solely to finance their accounts receivables. Receivables-based ABLs are similar to business lines of credit and offer similar benefits. However, they are easier to qualify for and are more flexible. To learn more about this solution, read “What is asset-based lending?

Do you need financing?

We are a leading provider of invoice factoring, asset based lending, and inventory financing. For a quote, fill out this form or call us toll-free at (877) 300 3258.