When customers don't pay, it can bring a business' operations to a grinding halt. But how should business owners handle their previously loyal customers who are now facing financial hardship- especially when the business is small and the customers are local?
Collecting on those nagging, outstanding debts from customers who cannot or will not pay has become a priority for many small business owners, and with good reason. Even if you prefer wearing glasses a shade of rose, it's impossible to deny that a significant population of small businesses are struggling these days- particularly in the area of revenues and, by extension, cash flow, as recently reported by this NFIB study.
While there are several tried-and-true debt collection strategies that small business owners can follow to help collect on outstanding customer debt, I'm not going to belabor that too much here.
Instead, I want to use this post to talk about the story behind the process: What do you, as a small business owner, do when a loyal customer suddenly can't pay his bill? And for those small businesses that cater to a local market, we're talking your peers and neighbors. You could try to take the guy to court, but you may see him in the supermarket the next day... All that potential negative energy will not be so good for business, let alone your standing in the community.
While every specific situation should be looked at on its own, for obvious reasons, there are some general things you can do to both protect your business and to show to your customers that you have a heart.
1. First, make sure to cover your back. There are several steps small business owners can take to help minimize the loss associated with bed debt:
- "Budget" for bad debt and record it on your financial statements. In accounting parlance, this is referred to as "allowance for bad debt." It appears as an item on your business' balance sheet that reduces the reported amount of accounts receivable.
- Claim bad debt as a tax-deductible expense. The original balance, plus penalties and interest applied to that balance, as well as expenses related to the collection efforts (such as court fees) may all be claimed as bad debt expense. For more information on the topic, see this page at irs.gov.
- Some small businesses may want to consider credit insurance (also known as trade credit insurance), an insurance policy that protects the insured business from clients who fail to pay their invoices due to insolvency or bankruptcy.
2. In cases of financial hardship, be open to compromise. Where there is good communication between the business and the overdue customer, try to work out a doable payment agreement or an outright settlement- even if it means taking a significant loss. You'll gain because you'll no longer have to direct time and resources towards collecting on the debt and you'll be generating good will between you and someone who may be a paying customer again somewhere down the line.
3. Evaluate debt collection moves involving third-parties before forging ahead. Many businesses turn to debt collection agencies to collect on their unpaid accounts. Fees for this service typically range from about 25% to 30% percent of the amount collected, though some agencies demand a split down the middle, and businesses can expect to see on average a 20%-30% recovery on bad debt. But the question is: is it worth subjecting a customer to a collection agency's hounding especially in situations where the debt in question is small?
As an aside, in almost all cases, avoid taking overdue customers to small claims court. Typically, the hassle (the paper work, the pre-case preparation, and having to personally go to court) and the cost (in fees) of going through the small claims process outweighs any benefits. Moreover, even if you technically win the case, you are still solely responsible for collecting the funds afterwords.
4. Think of unpaid debt as a charitable contribution. I know, this not such a comfort when you're also struggling financially, and hey, you didn't choose to make this "donation." But if you're stuck with an uncollectable bill, then you might as well see it in a positive light. And, what goes around comes around. You may end up gaining more, than the actual value of the outstanding account: a little piece of mind, a little goodwill, and a heart.