Debtor control: invoicing and collection
It is often said it's better to have cash in your bank account than a customers. Here are tips on monitoring and controlling debtor levels and securing payment on your terms
Commercial organisations normally give credit to their customers in order to encourage sales. In the case of charities it is less likely that you are encouraging additional sales by giving credit and more likely that your clients will want credit and will wish to dictate the terms on which they will pay. Therefore, for voluntary organisations, management is more about dealing with credit than deciding on a control policy.
- If you get the money in quickly you can use it for other purposes which will advance the organisation's objectives.
- Giving credit costs money, even if it is only a small amount of interest foregone. If you have an overdraft, the costs rise sharply.
- If a large client demands an unreasonable amount of credit you may have to simply walk away from the contract. You cannot afford to risk running out of cash.
- If stage payments are delayed, you may perhaps have to say, for example, that you will be unable to complete the contract; this may help with negotiations.
So what should you be aiming for in terms of the credit you offer? The key objective should be to try and shorten the period each year rather than lengthen it. So, for example, if you agree with your clients 30 days and you collect in this, you are doing very well.
A general rule of thumb is: agreed time plus 33%. You need to improve your collection procedures as soon as it slips towards this point.
Reducing the cost of debtors
- Send invoices promptly
The quicker invoices are sent the sooner they are paid. The best time to send them is at the same time as dispatching an order or completing a service. Do not wait until the end of the month as this automatically gives additional credit.
- Send statements monthly
Some organisations pay only on statement, though this is less common now, and it acts as a reminder for all debtors.
- Phone the client
When you see an invoice that has gone over your credit terms and your statement produced no response you should try to find out why. The best person to call is not always the person who gave you the order especially in large organisations. The purchase (or bought) ledger clerk probably knows most about the delay. If you have a few important clients it is often worth while getting to know the name of this person and speaking directly with them. They sometimes have the ability to speed up payment dramatically.
- Send a reminder letter
After about 60 days you should remind the client of the debt by letter asking for payment within 14 days.
- Phone again
If the reminder letter was unsuccessful, something may be wrong. Try to find out what and rectify the situation if possible
- Send a final reminder
When all the above fail, send a letter requesting payment within seven days. This should state that you will take further measures, legal action or withdrawal of services, if payment is not received.
- Stop supplies of goods or services
You reach a point where it is vital to stop throwing good money after bad.
- Send a solicitor's letter
By this time the relationship between you and your client will have broken down. Place the matter in the hands of your solicitor. Ask them to write to the organisation asking for payment before taking any other action.
- Take legal action
Legal action needs careful consideration. If there is a dispute over the goods or services, you must have a good case for taking legal action. Otherwise, hopefully, you would have been able to resolve this issue earlier.
Managing bad and aged debts
80% of your debts are probably from 20% of your clients or customers, so concentrate management effort on these.
An easy way of monitoring debts is to set up the finance system to produce lists of aged debtors at monthly intervals. Then all debts of, say, over £500 (depending on the size of the organisation) or more than three months old can be picked for intensive chasing. Alternatively, you could create a list of all debtors, the amounts and how old they are.
Part of your procedure to control bad debts should be that only a senior member of staff or the project leader can be allowed to write off bad debts. Similarly, the decision to sue should normally be reviewed for likely costs by the Finance manager to assess whether it is worthwhile, and by a lawyer to assess the chances of success.
Decreasing your debtor level
There are a number of tactics you can employ to encourage early, or at least discourage late payment.
- Offer discounts
Offering (say) 2.5% discount for payment within 14 days may result in early payment.
However, some organisations may then pay at their normal time but take the discount anyway. It will seldom be worthwhile to sue for the difference. All you have then is a 2.5% reduction in your price which the client or customer may expect to continue.
Furthermore, you have no control over whether the client will take up a discount. This makes cash forecasting more difficult. Also, you are at the mercy of interest rates - a discount which is worthwhile at one level of bank interest may not be advantageous if interest rates change, but you will have your contracts and stationery printed up in advance, and cannot immediately change them.
- Wait for cheques to clear
If you are selling goods by mail order or catalogue, you could consider not sending them out until cheques have cleared.
- Use merchant accounts
It may be worth setting up the necessary merchant accounts so that you can accept online orders with a debit or credit card - debit cards work out cheaper.
Monitoring debtor levels
It is very easy for an organisation to allow its debtor figure to creep upwards, and if there has not been any cash shortage crises these may not have been noticed quickly.
It is important to monitor the levels of debtors in relation to income. They should go up or down in line with each other. The key ratio to help you monitor this is the debtor collection period.
How to calculate the debtor collection period
- Determine income
Ideally, this should be the Income which involves credit. If, for example, the charity also has a shop which sells only for cash, then the shop turnover should, if possible, be excluded otherwise the average number of days figures will be lower than the ratio you wish to monitor.
- Multiply by 365
- Divide by the debtor figure
usually, it is adequate and easier to take the year-end figure; however, if there are very large variations in the year it is better to take an average figure. Important point - the true average is the average of 12 monthly debtors figures (or perhaps four quarterly figures). If there are seasonal variations which mean that the December 2003 figure is abnormally low (or high) then the December 2004 figure is also likely to be abnormally low or high.
- The result is the average number of days taken to collect debts, or the debtor collection period.
Read about procedures to control bad debts.
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