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Collections Policy

Article provided by Absolute Credit Control Services

I have always wondered if all businesses make use of accounts receivable processes, procedures, plans and strategies to overcome the ever-so inevitable threat of low working capital due to cash being tied up in unpaid debtors accounts.

In conjunction with sales, accounts receivable is one of the most critical areas to cover properly in business to be able to make ends meet as the lack of proper strategies may lead to the inability to cover day-to-day activities and requirements to survive. Ultimately, having a good Accounts Receivable strategy, should contribute to avoid bad risk decisions and reveal opportunities to apply better credit management processes to follow and adapt regularly based on market conditions and changes that could impact the business.

One key contributor to an Accounts Receivable strategy in the fight to avoid bad-debt accounts, is to have a process in place that guides the handling and recovery of outstanding debts from customers, in the form of a collections policy.

What is a collections policy?

A set of guidelines to govern the accounts receivable processes in handling due invoices from debtors. Normally, this forms part of the credit policy but the collections policy can be stand-alone to outline specific rules and requirements to protect accounts receivable and be transparent for both the customers and the collections team in building good customer relationships and motivating collections teams.

How can this be done? There is a process to follow from the time that the invoice has become due until it has been paid. The harshness of the collections policy will be determined by the size of the company, as smaller businesses might consider stricter timelines on customer contact and closely monitor progress to optimize their cash flow. They cannot afford big losses. Bigger corporations may in turn have a more lenient policy due to their access to greater sources of capital and prioritize customer relationships over quicker collection timeframes.

Tips that can be considered for collections policy and processes are as follows:

  • The timeline to contact customers:  One of the key actions collections agents must know is when to contact customers on their overdue accounts to maximise chances of payments being made. Even before an account becomes overdue, sufficient communication with customers regarding their invoices is important. Scheduling a calling cycle on the age of the debt does not only ensure customers are contacted and made aware of payments due but also to update changed information, find out if there are any unresolved enquiries, confirm payment dates and identify problem accounts early on.
  • Handling account disputes:  Once an agent has confirmed a customer has a dispute, all relevant information regarding the dispute must be noted properly to avoid any misunderstandings. It is wise to repeat back to the customer what is heard to make sure the detail of the dispute is correct and verified by the customer. If an enquiry is for an external department, it is important to confirm a follow-up date with the customer on feedback and notify that relevant department immediately after the call of the dispute for them to resolve the matter quickly. Keeping to scheduled follow-up dates ensures that the customer is not inconvenienced to call back and become annoyed. This contributes to the relationship building process and leaves a feeling of trust with the customer that the matter will be resolved, and payment will no longer be delayed. Chances are good that future payments from this satisfied customer will be paid within their agreed terms.

Dealing with an extremely angry customer should never be taken personally by anyone and all attempts must be made to diffuse the situation. Entering an argument with a customer to prove a point is not worth the time. The customer must be informed that he or she will be called back after a certain amount of time has passed to allow for a cool off period and then to calmly resolve the issue. If the agent and the customer have exhausted all efforts remains in an angry state of mind, it is best to hand the matter to the supervisor or manager in the department to further manage the dispute to resolution.

  • Collections agencies: Most companies result to external collections agencies when account invoices have reached the 60 days mark, and all means of collections has been exhausted. When a company has a good cashflow they may choose to keep accounts internally as the bad debt might not affect them drastically, but if the profits are low the risk might be too high, hence outsourcing their 60 plus days overdue accounts to external debt collector agencies would be considered.
  • Writing off bad debt: Once established that debt is uncollectable, it becomes a bad debt write off. However, this decision must be in line with the collections policy and every means of collection efforts must again have been exhausted. Resources to continue the collections process might end up costing more than the actual debt itself. Companies make provision for bad debt write offs and clear the value from the accounts receivable balance against the write off provision value assigned, no longer reflecting in the total book of accounts.

Managing exceptions

The world has a vast variety of different people that have diverse needs and desires, and sometimes situations require for exceptions to be made on processes that has been established for a while. Changing times, unexpected events, like the COVID-19 pandemic that hit us in 2020 for example, uncertain environments and trends, is often the culprit that requires for exceptions to be made and it is therefore deemed wise to have a flexible collections policy covering these and other adaptations to a degree.

Negotiating terms

Right from the onset, the terms and conditions of contract must include the payment terms on purchases or services rendered. As we mentioned changing times, customers might hit an unplanned roadblock and find it difficult to keep to their terms, require a new arrangement to be made such as extending the terms for an agreed period. For example, a customer who has an extended payment arrangement will not benefit from discounts offered until the account has been paid up to date. Further non-payment or default of the extended arrangement will result in no further negotiation allowed and full payment becomes due immediately or the customer will suffer the consequence of legal action becoming liable for legal costs over and above the account balance. This is mostly a stage in the collections process that nobody is fond of but unfortunately must have its place in the collections policy for total transparency on the consequences of defaulting on payments resulting in the legal hand over of accounts.

Measure collections policy

Why would it be so important to measure the collections policy? What benefits does it bring?

By implementing the processes and procedures in line with the goal to be achieved, cannot act alone in measuring the policy. There are other factors at play that contributes to the measuring process of the collections policy, and we can identify them as follows:

  • Performance of the collections team:  Monitoring the performance of the collections team could expose shortcomings or time-consuming actions that results in slow collections. The collections policy should be revised and optimized for better time management and work quality, regularly reviewed.
  • Days Sales Outstanding (DSO):  This is one of the best metrics used to measure the effectiveness of the collections policy, how many days are accounts outstanding before being paid from the time that the credit sale has been made. The DSO should be kept below a predetermined number the business agreed to but if this number is exceeded, the need to adjust the collections policy must be considered. Money should be coming into the business as fast as possible after the sale has been made.
  • Extended payment terms:  By extending payment terms for customers, puts strain on the cash flow as money is not coming into the business when expected. Extending terms should be avoided as it highly impacts working capital for the business, but businesses could still see an opportunity for future sales by overly accommodating customers late or non-payments. Customers with extended terms measured against normal term customers helps to determine the effectiveness of the extended term collections as well as the approval process thereof. Even if exceptions are catered for in the collections policy, careful consideration must still be adhered before granting a customer extension of their payment terms by means of reviewing the payment profile history to determine an ongoing trend. If a customer defaulted once does not necessarily mean it will become a recurring problem, however there are customers that may be labelled as serial payment defaulters and pose a higher risk. These customers are normally the ones that reaches the legal action stage.
  • Regular monitoring on extended term accounts to track profit: Companies need to know if it is feasible for them to allow extended term arrangements with customers and monitor the effect it has on their profit margin. If a company is suffering too many losses, the practise of extending payment terms should be avoided altogether. It is at the discretion of the company finance heads to implement the frequency of the tracking and remain knowledgeable on their financial standing as a result.

Finally, what are the benefits to measure the collections policy frequently?

  • Policies and procedures are regularly updated and improved to remain current
  • Identifying growth opportunities
  • Quality work output, optimized time management and productivity
  • Lower collections costs
  • Retaining customers through satisfactory service delivery
  • Improved cash flow and reduction in unmanageable debt

Remember to review and update your credit policy regularly to make sure it remains effective.

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