Many small businesses do a good job delivering their goods and services but then find it difficult to collect payment, often causing a cash flow crunch. This may be because the credit worthiness of a customer was not properly investigated in the beginning or it may be that insufficient attention was paid to monitoring and collecting invoices due. Either way, it behooves a business owner to establish reasonable credit policies, use proven techniques to optimize cash flow and enforce terms in a diplomatic but firm manner because "the sale isn't complete until the money is in the bank".
1. Optimize Cash Sales to Avoid Risk
There is no credit risk in cash. If your business allows for both cash payments and invoices, optimize the amount of cash, as a percentage of total sales, to the highest level possible for your industry or commercial sector.
2. Get Deposits Wherever Possible
Larger sales orders, produce-to-order manufacturing and, in particular custom orders, should require a deposit of 10-50% of the final purchase price at order time. This will go a long way to alleviating cash flow shortages and to also assuring the customer's commitment to the order. Deposits of this nature should be non-refundable.
3. Suggest Credit Cards to Secure Payment
Be sure you have the capability to accept major credit cards (Visa, MasterCard, America Express, and Discover). This is the next best thing to cash and reduces payment risk. In many instances, it also makes it easier for a customer to order. Customers who object to paying ahead of time may be assuaged by placing a "hold" on the amount of the sale against their card and processing the payment only after shipping the product or completing the service. This guarantees your payment (for a period, usually 30 days) yet doesn't appear as early payment to the customer. For credit card sales that are processed, your company account typically is credited by the credit card processing company in 1-3 days for a service fee of 2-3.5%.
4. Require Progress Payments for Work-in-Progress Orders or Contract Sales
If you manufacture a product or perform work over a long period of time, say several months, include in your sales contract specific times when payments are due (for example: 10% at time of order, 40% at 60 days, balance at completion). This will go a long way to avoid cash tightness and provide funds for continuing the project. In many contract sales situations, the amount of the deposit is effectively the profit on the order and is obtained upfront; the balance or cost of the product is then transferred from customer to vendor at normal payment terms.
5. Develop and Use a Credit Application Form
Every business, large or small that engages in invoiced sales should have a credit application. This can be as simple as a one page, faxable form giving critical information such as name and telephone number of the customer's accounts payable contact, department head and chief executive. The form should also require a minimum of two trade references and a bank reference. A key administrative person (in smaller businesses this is usually the Office Manager) is delegated responsibility for obtaining the information on the form, verifying the references and suggesting a credit limit based on the findings.
6. Set a Credit Limit for Every Customer, Large or Small
After credit references have been checked, a credit limit should beset for every customer. For small customers, the credit limit should be set based on their mid-level to maximum demonstrated payment performance. For large companies, a credit limit should be set based on the amount of risk your company is willing to accept and is a direct reflection of the percentage of your business you are willing to devote to one customer. Typically, concentrating over 10% of your business in one customer begins to be a risk; 30-50% is very risky and over 50% is potential disaster for your company. Bad things can happen to large companies as well.
7. Monitor Receivables Aging by Total and By Customer
At least weekly, calculate the average age of your outstanding invoices by customer and total. Assign responsibility (for example, the Office Manager) for generating and reporting on this information. Develop an "Overdue" report that shows every invoice 5 days or more past your terms. Set specific, reasonable goals based on your industry for "Average Days Receivables" and tie one component of your Office Manager's compensation package to achieving the goal.
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