Streetwise Credit and Collections

Maximize Your Collections Process to Improve Your

Profitability

Recommendation
Knowing how to extend and manage credit can mean the
difference between a profitable small business and a
bankrupt one. A problem borrower is a dangerous
nuisance that wastes your time and money, and raises the
specter of potential litigation. That makes Suzanne
Caplan’s book on managing cash flows and credit
particularly useful. This straightforward manual presents
clear information, including sample collection letters and
step-by-step suggestions on resolving collection issues.
Caplan uses real-life examples to supplement her ample
basic information on issuing credit and collecting
payment. getAbstract finds that her practical book can help
small business owners or managers dodge the hazards of poor credit practices.

Take-Aways
 Managing credit and collections is a critical business function.
 Business managers must balance cash flow with their ability to pay expenses and extend
credit.
 Businesses can get money from their owners, lenders or investors, from suppliers who
grant favorable terms or from factoring firms that purchase their receivables.
 Business owners who grant credit must be able to gauge the ability of customers to
handle the debt.
 When you grant credit, make sure it is beneficial to both parties.
 When a business extends credit to another business, the two firms essentially become
partners, since the credit process allows both businesses to grow.
 If you buy from an overseas supplier, purchase through a known importer, hedge against
currency fluctuation and pay only after inspecting the goods.
 When filing a judgment or lien, do it sooner, rather than later.
 The Equal Credit Opportunity Act and various state laws protect U.S. consumers.
 When collecting debts, be polite, so you can preserve the business relationship.

Summary
Promises to Pay

Credit and collections are critical to any business. The lack of an accurate, continuous
credit process can jeopardize your cash flow and your operations. While many business
owners use their own money or bank loans as their primary sources of capital, they
sometimes turn to outside investors. As your business expands, credit lets you leverage
your assets to finance its current activities based on its future, anticipated revenue
streams. Companies follow natural cycles, and their cash positions can ebb and flow.

When Small Businesses Need Money

Start-up businesses frequently rely on their owners’ capital or on bank loans for infusions
of cash. Understanding your company’s cash flow is crucial since it dictates your ability
to operate and to extend credit to your customers. Watch your debt-to-equity ratio
and maintain sufficient cash to meet your debt obligations on time. Most credit problems
occur as a result of the debtors’ inability to pay, rather than their intentional decision
not to pay.

“Your best protection against an unsuccessful collection is to understand how much and what
type of credit is needed by a business or consumer, and how to follow through with a policy that
reflects that knowledge.”
Businesses also can convert inventory into collateral to pay bills or secure loans. Lenders
will examine how long your invoices have remained unpaid and they may also evaluate
the creditworthiness of your customers to gauge the quality of your collateral. Typically,
lenders make loans based only on current receivables. When a business needs to fund a
long-term project which will not immediately produce regular payments, it may require
a bank loan or, in the U.S., assistance from the Small Business Administration. This often
requires a use-specific loan where the money is designated for buying materials and
paying labor costs, or the like. In industries with large capital inventories, such as autos,
furniture or appliances, banks may finance the entire inventory and hold it as collateral.
The store repays the bank as it sells the inventory.

“For the most part, credit is about good intentions and not the force of law.”
You can also sell your firm’s accounts receivable to a third party, or “factor,” who
collects payments from your customers in exchange for assuming the risk of
nonpayment. You receive a draw against an open line of credit extended by the factor.

Setting Up New Suppliers

Seek suppliers who not only provide the best products at the greatest value, but who
also have favorable credit terms, like 30-day invoicing and the willingness to ship goods
without cash in advance. Suppliers who are competitive in business will also compete
more on credit terms. Established firms with no competition, like utilities, have the most
rigid, least competitive, terms.

“Obtaining credit is the most common way a business can leverage its assets and smooth the
timing of its cash flow.”
To establish credit with a new vendor, share information and demonstrate your
dedication to your business. Even if your new company does not yet have a credit
history, you still can negotiate favorable payment terms with a vendor, perhaps by
offering to pay half the bill on delivery and the balance within 10 days. Another alternative
is taking goods on consignment, meaning that you hold goods to sell, but the supplier
still owns them. With consignment, the vendor checks the inventory and bills you for
what you’ve sold. Consignments can supply a new business with inventory with no cash
outlay.

Consumer Versus Business Credit

In the U.S., federal laws govern how businesses handle consumer credit. The Fair Credit
Collection Act sets parameters for credit practices. When a business extends credit to
another business, it must determine the borrowing company’s ability to pay. Check the
references and reputation of the business’ principals. Ask for their personal credit
reports and their personal guarantees on their credit application. Use your personal
guarantee as a psychological lever in gaining payment, although it may have little legal
standing, depending on jurisdiction. If the principals have declared bankruptcy in the past
or operated companies under various names, that is a red flag about how they handle
their financial obligations.

“Receiving credit is a business necessity.”

A business owner who grants credit should be able to gauge the customer’s ability to
pay. Use your judgment. When you grant credit, make sure the transaction benefits both
parties. A customer who assumes too much debt can become a high-risk debtor and
could default. This has even greater ramifications if your business sells the debt to a third
party. Credit-issuing companies face long- and short-term risks. For instance,
construction projects that can extend for a year or longer often earn phased payments
as they reach certain benchmarks. Make sure that you define the benchmarks clearly and
that the customer adheres to a schedule.

Going Global

Moving into the overseas market may be an opportunity, but it presents risks for small
businesses. When buying goods overseas, minimize your risks by purchasing through a
reliable U.S. importer, hedging against currency fluctuations, and specifying that you will
pay only after inspecting the goods. To facilitate paying overseas companies, have your
bank issue a letter of credit, in effect, using its standing to vouch for your account and
your ability to pay. Letters of credit contain much of the same information as purchase
orders, including payment and shipping terms, inspection procedures, a return policy
and fulfillment terms defining when the letter of credit ends. Standby letters of credit
present the bank’s ability to pay as a backup.

The Basics of Extending Credit

Before you offer credit to your customers, develop guidelines about payment terms,
how much credit to extend and whether it will be secured or unsecured credit. Secured
credit is backed by collateral (inventory or equipment) you can repossess in the event
of a default. Unsecured credit is issued without any collateral.
“Establishing credit from vendors is a low-cost source of capital that can benefit every company.”
Be sure your cash flow can cover paying your expenses as well as extending credit.
Administer your credit department rigidly and staff it with full-time professionals only.
Their duties include establishing new credit accounts for qualified customers, setting
credit limits and monitoring payments. Good credit management includes filing payments
and original invoices to keep customer accounts current. Maintaining records of any
customer correspondence and being diligent about accurate billing is important since
those records and transactions can become part of the collection process. Send
statements on a regular basis and file signed copies of packing slips, bills of lading, proofs
of delivery and completion orders.

“The most difficult type of business activity to fund is a project that takes a long time to complete
and does not offer advance or progress payments.”
When your business extends credit to another company, that firm becomes, in effect,
your partner since the credit-granting process helps both businesses grow. When you
decide to extend credit, determine how the other business will use it and be sure you
are extending the right amount. Determine if you want a personal guarantee from the
owners of the borrowing business. Giving too much credit can risk reducing your
working capital. To avoid that, learn your industry’s credit requirements and customary
cash flow patterns. The way your customers use credit and the cash flow cycle in your
industry should shape the framework of your credit policy.

“When you are selling to consumers, you don’t want to appear as if you are motivating them
to get into debt over their heads.”
Protect your business with written contracts and purchase orders that specify terms for
both parties. The elements of any contract include the subject of the work or service
provided; price and payment terms; delivery dates; the definition of default; and any
guarantee or warranty. In the event of any disagreement, the terms in the document will
prevail. Therefore, project managers must submit change orders in writing so they can
be attached to the original contract.

Collecting Debts

Despite your best efforts, some people or companies will not repay their debts. Start
your collection efforts with a phone call. When you contact a corporate customer, try
to find a solution. Ask about the firm’s financial situation, and see if its owners will co-
operate in a payment plan. Ask for a payment schedule and, if practical, a partial payment.
With a financially strapped business, try to set a realistic schedule and amount given its
cash flow and situation.

“Once individuals or businesses have failed to pay you, should you ever give them credit again?”
When trying to collect from a consumer, circumstances are somewhat different. In the
U.S., the Equal Credit Opportunity Act and applicable state laws protect consumers.
Collection agencies must abide by Fair Debt Collection Practices legislation that governs
dealings with individual consumers. When customers refuse to respond to your
collection efforts and write to the collection agency saying they no longer want to be
 contacted, the agency must break-off contact. If a debtor files bankruptcy, you must stop
all collection efforts until you can resume in court.

“If you set the right value on your product or service and deliver it in a professional way, payment
should take place seamlessly.”
If you are collecting a debt using in-house resources, be cordial with your debtors since
they could still become customers again. Try to establish personal relationships. Perhaps
you can obtain a confession of judgment, giving you the right to claim payment without
any other legal actions, but both parties must sign it. The courts can disburse judgments
using a debtor’s financial accounts or property. If a customer will not take your call, send
a strongly worded letter via registered mail. Warn the customer that you will have to
turn the matter over to a collection agency. Then, do so if any of these events happen:

 The account becomes 90 days past due.

 The customer breaks payment promises.
 The customers disconnect their phone.
 The customers say they are unable and unwilling to pay.
 The customers argue about the quality of the merchandise or service they received.

“Intimidation will not generate cash if the debtor’s financial problems persist.”
If the collection efforts fail, you may find relief in small-claims court, where often you
can press your case without using an attorney. In the U.S., small-claims courts in each
state have their own limits on the collection amount and processing rules.

If you have to evict a tenant for failure to pay rent, first terminate the lease. Give the
tenant legal notice of this pending action and include a date to vacate, a reference to the
lease’s terms, the date it was signed and what will happen if they don’t pay. Eviction
proceedings differ in each state. If tenants say they are vacating, ask them to find another
renter to fill out the lease, renegotiate the terms, or terminate the lease if they agree to
pay and leave. In a residential building, locking tenants out of their apartments is illegal
without court approval. Since tenants can stay in an apartment pending legal eviction
even if they cannot pay the rent, they could damage the premises. That is another reason
to stay on good terms with your renters, even as you urge them to move voluntarily.
That’s the best outcome since eviction can become a costly, time-consuming, messy
process you want to avoid if possible.

Courts and Bankruptcy

When someone owes you a large sum and you can’t collect, turn to an attorney. Lawyers
can complement your firm’s collections department, and help you win judgments that
give you the right to file liens. However, once you win a judgment, it must be executed
and converted into cash. Serve the judgment on the debtor’s bank. If you are filing a
judgment or lien, do it earlier not later, so you are in line for at least partial payment if
the debtor goes bankrupt. The date of your filing plays a role in whether you will be
considered a secured or unsecured creditor. Most collection cases are settled between
lawyers and do not involve courtroom appearances.

“Money is power – and there are those who like to play power games involving money.”
 When debtors have no other recourse, they can file bankruptcy. The three main types
of U.S. bankruptcy each affect creditors differently:

 Chapter 7 – This kind of bankruptcy liquidates the debtor’s assets for a trustee to
distribute to creditors. The 2005 federal bankruptcy law requires Chapter 7 debtors to
make some payments on their debts.
 Chapter 11 – This bankruptcy format applies to businesses that can keep operating
under trustees as they develop new payback plans. Creditors receive monthly reports
from the debtor. Creditors then vote to determine if the business should close.
 Chapter 13 – Under this bankruptcy provision, debtors send part of their monthly
incomes to trustees who distribute payments to creditors on a pro rata basis.

About the Author

Suzanne Caplan, a 20-year CEO for a small manufacturing company, is a frequent
speaker and a small-business consultant. She also wrote Turn Your Business Around!, The
Small Business Insider’s Guide to Bankers and Streetwise Finance and Accounting for
Entrepreneurs.