Last week I discussed Credit, today I will discuss the rest of the phrase Credit and Collection. Like the Credit process, how you run your collections process is important and deserves your attention. If you have a good credit process up front, you are probably OK on the reasonable expectation of collection criteria for revenue recognition, but you still need to collect the cash for your sales.
I will assume that you have a good credit process and you are selling to customers with reasonable credit. I will also assume that you have a good sales contract. In place, but I will discuss that in a little more detail. If your credit process is broken, you will have collection issues. That time two months ago when you caved in and said yes to make a quarter even though the customer had bed credit? This is where you face the music and have to deal with the consequences.
Your sales contract and/or invoice needs to make payment terms clear. I mean very clear and spelled out in proper terms. Incoterms or International Commercial Terms is well understood and often used in international commerce. Because these are well understood and legal interpretations are clear, I highly suggest that you use them. Make sure the terms are in the contract and either on the invoice or the invoice references the contract for payment terms. Be especially careful what the customer purchase order says. Many countries defer to the purchase order when settling disputes regardless of what the contract says unless the purchase order says otherwise. It almost can become an arms race where there is a contract, then you receive a “standard” purchase order back that does not reference the contract, then you send an order acknowledgment reaffirming that the order is accepted under contract or invoice terms. Every country is different, so I suggest you consult your lawyer here, but you do need to be careful.
I know it sounds pedantic and overly detailed for the new, strategic CFO, but every company needs cash and you are not going to be able to be strategic if you don’t collect well. Getting the contract done well, even if just contained in your standard invoice terms, is something that can be done well once up front and then just needs a little bit of maintenance and supervision going forward, something that your billing team can handle without much effort from you. I always check this process when I start a new CFO job (applies to Controller as well). If it is in good shape, then I manage on a exception basis. If it is in bad shape, I put a lot of attention to it very early.
One last tip that can help later is to try and preserve title until payment is actually received. You need to be careful about affecting revenue recognition as one criteria is title has to transfer, but a properly worded term and the expectation that you will be paid is normally sufficient. You also need to be sure that it is clear that they are responsible for losses and need to insure the goods.
The next step to good collections is to get your sales force engaged. Hopefully you are already doing all the basic things that build trust and relationship with the sales team (I find adult reviews of expense reports that allow for some discretion and paying them quickly once submitted really helps here.
You need the sales team engaged because they are the ones talking to the customer and doing the negotiations. So if you want something built in up-front, then the sales manager is the one that will do it. If you want a purchase order that resets terms caught, it will be the sales team that sees it first.
I know of two ways to get the sales force to help. The first is training. Take the time to train them in the standard payment terms the company uses and why they are important. Educate them on the main cash flow levers the company has and what the time based cost of money is for your company. Show them using examples just how much a bad debt costs the company. Show them how a side agreement can throw all the prep work and standard contracts out the window. Side agreements are import enough that I will do a blog entry just on them. If you spend time educating the sales force, you greatly increase the chance to get them on board and engaged.
However, this is just not enough. Sales people are very motivated by targets and pay associated with the targets. If their bonus is only based on making the sale, then they will not be motivated to put potential barriers in their own way by protecting the company. You absolutely should tie some of their bonus to eliminating bad debt and collecting the sale. The best way I have found to make sure they are motivated to keep following up with the customer is to only give them credit for bonus purposes when the payment is made. This is the simplest and most direct way to tie their behavior the the company’s hoped for result. More mature companies can also have metrics for bed debt and finding costs for the receivables the sales group creates, but no credit for bonus until collected is the most straightforward.
I get pushback at times from sales managers on this (I always try and stay engaged with the sales team as they are the best and earliest warning system for forecasting and customer feedback). Normally them complain that our harder terms are bad for their customers. My answer is simple, a “customer” that does not pay is not a customer. If I am being less polite to really make the point, I remind them that people that take things without paying are thieves.
I am sure that you have noticed that many of my blogs emphasize the up front process and usually I spend a lot of time explaining what I do to get it right. That is my natural instincts coupled with Six Sigma training. In a factory, the worst process to follow is to inspect quality in at the end and the best is to start with your suppliers so that you receive good quality parts. It is the same for Finance processes. One topic I did not cover here is billing, your invoices need to be perfect or whatever mistake is present will be used as an excuse not to pay, but I will discuss that another time.
I have noticed over the years that you should have very nice, persistent and organized people actually doing the collections. As funny as it is to joke about breaking people’s legs and all the other loan sharks collection methods, people do not like to pay mean, threatening counterparties. All you really can do is threaten to sue and in the USA that is not much of a threat. If there is either a cash flow issue or some form of quality dispute with the customer, they are not going to care about a lawsuit.
What actually works is polite and persistent follow-up. The customer will claim missing invoices, terms being different than what is in the contract, quality issues, moon phases, sun got in their eyes, vacation schedules of people who can sign cheques, pretty much any reason under the sun as a reason for delay in payment. Your collection team needs to document that they were told, efficiently follow-up internally for anything that is under your company’s control and then get back to the customer. They need to sound sympathetic and be very polite about identifying inconsistencies in what the A/P person at the other end is says. Quite often pure embarrassment at being caught in a lie (that is never specifically claimed by your collection staff) can cause the customer to pay.
If your team is polite and professional and keeps good records (CRM is best but a physical file works), you will get prioritized for payment. If there is a real issue, your collection team will find out because the people on. The other side will tell them because of the good relationship that has been built up. Your collections team should either work closely with the credit team or report to the same boss so that you get realtime feedback and can stop further sales if a customer suddenly turns bad. I don’t consider a company being protective of their own cash flow to be bad. If your invoice to them was incorrect then you gave them an excuse not to pay. Anything that you would do yourself needs to be responded to with polite but firm follow-up.
Finally, if a customer does not pay you need to take legal action. Your sales team will protest about relationship, but a customer that does not pay you has already broken their relationship. If you have credit insurance, your insurer may take over this process, otherwise you need to sue. The steps are always the same. First a legal warning letter then you file a claim. You need to get paid, not a future promise of payment after the legal warning letter as you need to move quickly.
By doing what I suggest in this blog, I have consistently been able to deliver industry leading collection statistics wherever I have worked. By spending the time to work more directly with the credit and collections team and build a rapport with the Sales team I have been able to keep everyone happily working towards the goal of getting cash into our bank faster.