Receivables Reduction

COST OF RECEIVABLES

Failure to keep control of current accounts receivable can have disastrous effects on the cash flow of a business. Assets mean nothing to creditors; cash flow pays the bills.

When someone fails to pay on time, they are using your money. You're losing the opportunity to reinvest that money in either your business or another opportunity. Even receivables that are just a few days old can have significant consequences. The chart below shows you how much money you're losing if you have $100,000 in outstanding accounts receivable, at three different rates of interest, and assuming daily compounding (which would essentially occur if you were paying yourself). The nominal current day rate is 8%, 10% is the stock market's average rate over time, and 33% is roughly the average stock market return last year:

THE TIME TO ACT

Receivables control begins before a job is invoiced or work is billed, even before the bid or estimate is prepared. It starts with the selection of your client and agreement on contract terms.

Your Customer

You wouldn't rent your house to someone without at least a minimal background check. Why would you give credit to customers without the same protection? They'll check into your background and the quality of your work. Afford yourself the same protection. Why would you work with someone with a known history of delinquent or late payments?

Desperation for work is the worst reason to accept a job. The money you're owed can earn a better return in an adequate investment vehicle, and this lost opportunity is hardly compensated by someone stringing out their payments-without interest, even!

If you want to work with a general contractor, get names, addresses, and telephone numbers of at least three suppliers (five is better) and ask them:

• Does the contractor pay his bills on time?
• Is the contractor currently delinquent or late?
• Have there been any complaints about the contractor from either customers or other contractors, and if so, what were the nature of the complaints?

Contractors who refuse to give these names probably have with something to hide, so don't enter into the venture. Get the name and address of the contractor's banker, too, and ask whether he or she considers the contractor a good credit risk.

There's no difference between the general contractor and the end customer: Credibility begins with the proven ability to pay the bill. The general contractor might not have researched the customer. If your payment depends on the end customer's payment to the general contractor, it behoove you to whether the contractor has done a background check on the customer. If this has not been done, do it! The same routine applies: Ask for three to five references and the key questions.

The Contract

The contract has three basic elements: (1) what you are going to do, (2) what the other party is going to do, and (3) what happens if a party to the contract fails to do what it is supposed to.

A contract need not be "legal" to be legally enforceable. It does not even have to be in writing-but some documentation of the agreement should exist in the event of a disagreement!

The contract should unambiguously state what the agreement is. Street language is unacceptable to a third party (i.e. judge or arbitrator) because of its ambiguity. "Legalese" is difficult because nobody understands it-even the lawyers, sometimes! Technical terms are acceptable if everyone understands what they mean. If one of the parties does not understand what a technical term is, it should be defined in writing. Even if both parties understand it, it's wise to define it anyhow for a third party (judge or arbitrator).

To encourage timely payment, your contract should include terms of interest on unpaid balances and a discount for early payment. Discounts for early payment (within the first 10 days of billing) typically run 1.5%. If payment is not made within 25 to 30 days of billing, interest should start accruing from the billing date. Beware of usury laws. Unless you are an exempt institution, such as bank or other lender that has registered as such with the appropriate governmental agencies, you are allowed only 5% above prime or 10% per annum (simple interest), whichever is greater. Exceeding the rate prescribed by law will nullify any interest payment agreement and may render the entire contract unenforceable.

Finally, have an attorney you trust review your contract to ensure that it says what you think it says. Be prepared to tell him or her-without reference to the document-the details of what you're doing, what the other party is doing ,and the consequences if things don't happen as intended.

RECALCITRANT DEBTORS

All businesses eventually face the inevitable bad debt. Payment is just difficult to collect for some jobs, despite your best preparation. Follow up on your bad debtors in three steps: (1) telephone call with follow-up correspondence, (2) attorney letter, and (3) litigation if necessary.

The Telephone Call

The day (or at most the day after) a receivable comes due, place a telephone call to the debtor reminding him or her of the obligation to pay on time. This should be a friendly phone call-a simple reminder or follow-up determining whether the customer has any problems with paying or with the service or product you provided. If there's a problem with either the product or service, make every effort to resolve the conflict as soon as possible. If the debtor is only having a cash-flow problem, discuss alternative arrangements. It's absolutely necessary that your customer be confident enough in you to deal with you candidly. Suggest that if there is a cash flow problem, now would be the best time to discuss some sort of resolution to avoid unpleasantries later.

An absolutely necessary corollary is to follow up that phone call immediately with a letter documenting the amount due and that (1) payment was assured as forthcoming by XX date, or different terms if agreed upon by you, (2) interest on the amount due will be assessed at XX dollars and cents per day until received, and (3) you appreciate the business.

The Next Step

We've all been there: the customer assures us that there's no issue with your product or service and that there's no cash-flow problem. This is not unusual-many can't admit a cash-flow crisis even to themselves.

The next step is a letter stating (1) the amount now due (including principal and interest), (2) the earlier agreement to rectify the problem, (3) that interest continues to accrue at XX dollars and cents per day until payment received, and (4) that if payment is not received in full within 10 days, the matter will be referred for further legal processing.

Resist the temptation at this point to engage in further telephone conversation with the debtor about the problem debt, because there's a great danger of being lured into even more lackadaisical collection practices (deferring payment again, reducing the interest charge, etc.). Any conversation with the debtor should make it emphatically clear that nothing less than full payment received by the due date will be acceptable. You may consider crediting a portion of the interest charge to future billings, but this should not be applicable until full payment is made.

Legal Recourse

You loathe the legal system, but you've waited long enough. Now you must carefully weigh the benefits and costs of proceeding with legal action.

Engaging the services of an attorney to litigate a matter for you generally costs a minimum of $2,000. Obviously, the amount may increase with the complexity of the case. A minimum base line for hiring an attorney to litigate a case should be established in your analysis of the situation; $10,000 minimum debt is a general base figure to work with, although in today's economy even that figure may be too low to justify hiring a lawyer.

Debts up to $5,000 should be prosecuted in small claims court without hesitation. The cost is minimal. The only adverse consequence is the amount of time spent at court.

Debts between $5,000 and $10,000 are more difficult to assess. Remember the cost of an attorney. The closer the debt is to $5,000, the clearer the choice is to proceed to small claims court and write off the balance as bad debt. The closer the debt is to $10,000, the more careful you must be in managing your litigation. You need to have control over your lawyer's actions, while recognizing that your lawyer will have no control over some situations. Creative use of additional resources, such as independent paralegals, can help control some costs. Hire the attorney for crucial items, such as court appearances. Hire the paralegal for lesser matters, such as preparing responses to interrogatories. If your lawyer doesn't like this kind of arrangement, get a new lawyer; the business climate for lawyers is much too competitive for any lawyer to determine the client's service level.

Debts between $10,000 and $25,000 are the subject of Municipal Court. A lawyer's assistance is highly advisable; the only difference between Municipal and Superior Courts are the amounts being sued over and minor limitations on the discovery process. Consequently, the costs can mount quickly. Again, control over your lawyer is paramount to a cost-effective resolution.

When the debt exceeds $25,000, it becomes a matter for the Superior Court, where the discovery rules are much broader and the road to recovery thus longer and much more expensive. The key to minimizing the amount of time spent pursuing a debt depends on how complex the subject matter becomes. In this area, a common defense tactic is to vigorously pursue unlimited discover to broaden and confuse the issues. When the debt exceeds this amount, it's difficult to control the attorney functions because of the attorney's fear of liability. Honest communication and a clear, realistic disclosure of the ultimate outcome you want will help minimize the amount of time spent on fruitless discovery and getting the case heard.

BASIC RULES OF LITIGATION

1. Request copies of all documents generated in your case.
2. Question your attorney about all areas of strategy and the case.
3. Demand clear and simple explanations.
4. Don't be afraid to challenge the advice of your attorney.
5. Don't be afraid to have the matter independently reviewed to ensure that all possible avenues of theory and strategy have been explored.