The High Cost of Collections

The High Cost of Collections


One overhead expense that plagues every business is the cost of uncollected debts. One customer refuses to pay, another runs into financial difficulties after work is completed, a third uses a stolen credit card and disappears into the night. Incidents such as these hurt established businesses but can spell death for a small or start-up business. There will always be a small contingent of people who don’t pay bills, but there are ways for businesses to avoid the high cost of collecting bad debts.


When it comes to collections, the best defense is a good offense. Start every business transaction with a clear outline of each party’s responsibilities, including a payment schedule. Too often, especially when a novice deals with friends or family, the contracts are verbal, and go something like this: “Pay me when you can.” It’s amazing how many of those “friends” never get the money together to pay the bill for services, but find a way to purchase beer, cigarettes, lottery tickets, and a big screen television. A good contract always lists dates and amounts due and is done in writing. This is especially critical for service-oriented firms; it’s difficult to repossess transcription services, daycare, lawn mowing, or carpet cleaning.

Second, get a deposit or down payment, and always give receipts for these. There is less resistance to complete paying for a job if some payment has already been made, and the deposit or down payment may cover most, if not all, of your cost to do the job. If the customer ultimately does not pay in full, you haven’t profited but you haven’t lost money.

Third, assume 5 percent of your clients won’t pay and build a cushion into your price schedule. Spreading the risk of bad debt with a small markup from the outset prevents scrambling to make up large losses at the end with a large markup. Loyal clients who are facing a 20 percent increase in price with no increases in benefits to them are likely to start shopping.

Finally, never allow one customer to become a significant source of revenue. If that customer falls into a bad financial situation, their problems ultimately trickle down and every vendor servicing the account then faces a bad debt. One prime example of this occurred when a small commercial printing company allowed an advertising agency to become almost 25 percent of their business. This particular agency dealt exclusively with homebuilders. One of these construction companies was cited for shoddy workmanship, sued by a number of homebuyers, and went bankrupt. Every job the agency did for them went unpaid, and the printing company was forced to close its doors after over 30 years of business.


It’s incredible how many bills go unpaid because customers have questions, reservations, or are unhappy with the work done, and were never contacted about those concerns. A little follow-up on the part of the sales or customer service staff during the job and upon completion can go a long way toward preventing bad debts. Communication is the key here, and the business owner must keep the lines open. A surprising number of customers never pick up the telephone and complain to the business directly, but they may write a bad check or contest a credit card charge, leaving the accounts receivable department to deal with the bank, an irate customer, and an uncollectable debt. A follow-up by sales, on the other hand, offers the opportunity to fix the problem, satisfy the client, and potentially sell other services during the problem-solving transaction. Not only will the customer feel they were heard and are important, they may also show their gratitude by spending more.


Some situations will ultimately spiral out of control or circumstances hit out of the blue. Some clients honestly intend to pay, but fall into financial difficulty through divorce, job loss, or medical problems. Some customers just need a gentle nudge to get off dead-center and make payments; others need dynamite. For these situations, the business owner should have a collections policy that allows good customers in hard times to save face, and bad customers to face consequences.

Allocate some time daily to call clients whose bills are past their due date. Keep notes of any conversations you have with a human; these notes are invaluable if the check doesn’t come in the mail but the customer’s story changes over time. If the customer makes arrangements for a payment schedule, make a note of that and follow up in writing with the client, reiterating their stated agreement. Of course, keep a copy of that correspondence for your files. If the client says there was a problem with the work, ask if they told anyone about it, such as sales staff, service providers, etc. Try to get names; too many times, problems and complaints aren’t passed to the owner or the accounts receivable department. Be certain you have the whole picture before taking any further action.

The last resort, of course, is collections. For most businesses, it’s best to outsource this step to a professional collections agency. This keeps your business from becoming “the bad guy” in the eyes of the customer, and this allows your employees to focus on more productive activities. Turning outstanding accounts over to collections also affects the nonpaying customer’s FICO score adversely, which may motivate them to pay before more serious consequences, such as small-claims court, are imposed. These people will probably not contact your company for services again, so be aware that collections can’t be used in a heavy-handed way. But writing off these debts without a fight sends the wrong message and ultimately devalues a company’s work. It also acts as a magnet for more of the same kind of clients.

Credit is a necessary part of business, and extending credit carries risk. Minimizing collections risks can maximize business growth and keep both clients and business owners happy.