There is so much pressure on small businesses to 'make that sale'.
However, a sale is not real income until you receive payment. It is easy to see the balance on your receipt book/online sales tools mount up. It's exciting and feels rewarding. The problem is you can quickly run out of cash if those sales don't follow through with payments.
Prevention
There is no magic 8 ball which will guarantee a customer will pay in 30 days. For retailers, this is slightly easier as you receive cash/card payment on sale. But for anyone else, consider the following:
1. Deposits- to at least cover the cost of your materials and labour
2. Retainers- Charge a monthly fee to contribute towards a service delivered in the future
3. Get a purchase order (PO) - A PO is basically a pre-authorisation for an invoice to be honoured. Software like Xero and QuickBooks makes it easier for SME's to produce these. So, when you make a sale ask your customer to provide one and add to your invoice.
4. Research - Don't be afraid to look up that customer, a quick google search is no harm
5. Credit checks - there are agencies you can use, but also, use companies house (I will go into this further below).
6. Set out very clear terms of sale/contract covering not just payment terms, but how you address non-payment. This will help you later on with any legal recourse you may have to take. An invoice is not enough.
You have to remember if someone really wants to do business with you, they will not be insulted if you apply conditions of sale. You are a small business, be prepared to stand your ground.
Using companies house
A very underused, free way to check business customers, is to look up their company accounts. Yes, these can be up to 18 months old, but they can tell you a lot. First, make sure their registration number is valid and that they are in fact register where they claim to be. If not - Warning sign 1.
Second, check their balance sheet. If their current assets are less than their current liabilities figure, this indicates a problem to pay (liquidity ratio should be 2:1- current assets to current liabilities). Also, look at the retained earnings figure and bank balance. Is there a growing deficit between the current year and previous year? If so, this also indicates potential problems. Warning sign 2.
A company statement can be quite old, but that shouldn't stop you asking questions.
Finally, don't rule out the benefits of social media. You can ask around through groups and other contacts, just don't libel anyone!.
Addressing a potential bad debt
It happens. You send an invoice and expect payment within 30 days. Nothing happens.
Firstly, have a non-confrontational call. You may have sent an invoice without a purchase order number or sent to the wrong address or provided the wrong bank details. Establish the facts, as it could be a simple mix up.
If they do not engage. Send a formal warning. This is termed a 'Dunnings' process. Credit controllers and accountants send 'Dunning's letters' to those who have failed to pay within the agreed time frame. Standard practice is to send a few before progressing to legal recourse.
If by month 4-6 there is no sight of payment you have a few more options:
1. Offer a payment plan - if they are in financial difficulty
2. Solicitors letter - weight up the cost benefit of doing this
3. Small claims court - again weight up the cost of legal action version writing off
4. Is there a barter option, if they are struggling, can they provide stock/good in exchange?
5. Factoring/invoice discounting - you can sell the debt to someone else at a discount. Work out if the cost works for you. Has pros and cons.
Write off
For calculation tax, you or your accountant use sales less allowable costs to work out taxable income. Even if you have not been paid, if you declare that Income you have to pay tax on it, unless you either issue a credit note or write off formally:
1. Credit note - by issuing this from your accounting system, you are reminding that customer of the value they that have taken from you.
2. Write off - you will technically have to record why you are writing off this sale (company minutes) or attach backup to the accounting entry.
For either option, you must evidence that you tried best effort to collect on the sale. Otherwise, the tax authorities for your jurisdiction may ask you to include as income and pay taxes on that amount.
Conclusion
The effort taken to remedy a bad sale can take its toll. So take time before completing a sales to check who your customer is. If you get a bad feeling, don't be afraid to investigate.
The above is not going to give 100% protect you, but can lower the risk.
I haven't covered, on purpose, what happens when there is a refusal to pay due to poor quality. This can be a genuine complaint from a customer. So, do set out in your terms of sales a process to address issues. Set customer/client expectation early in the sales process so that you cannot be accused of not delivering what you promised. Document expectations and have a point of delivery check.
