Tax & admin · 15 January 2018

A simple guide to effective credit control for small business owners

Paid and Unpaid. Two binders on desk in the office. Business background
A credit control system is an effective way to recover unpaid invoices

For the second instalment of a new series tackling cash flow for small business owners, Grid Law founder David Walker looks at how to make a credit control system more effective.

In every business, getting paid for the work you have already done should be your number one priority. Even if your business is profitable, it can be forced to close if you’re not being paid on time and it runs out of cash.

If your clients pay up front for your services or they pay for your products at the time of purchase, credit control isn’t going to be an issue.

This is the ideal situation for your business to be in, so before you think about credit control, think about whether you could restructure your business to take more payments up front. The more you can, the less risk you will be exposing your business to.

Take a look back at the first article in the series: A change of mindset is needed to solve the UK’s late payment problem

If you can’t take payments up front (and I really challenge you think about whether you can’t or you just think you can’t), or if you choose not to ask for all or some of your payments up front, you will be offering your client a line of trade credit.

This is extremely common and some of your suppliers are probably providing you with a line of trade credit too. Most of the time this works well and it certainly helps with cash flow but there needs to be limits on it.

Think about it this way. Would your bank offer you an open-ended loan without any consequences for not paying it back? Certainly not.

If you don’t have effective credit control procedures in place this is effectively what you’re doing for your clients. Your trade credit is providing them with an open-ended loan and easing their cash flow at the expense of yours.

So, you need an effective way of recovering your unpaid invoices and this is what your credit control system is for.

Your credit control system doesn’t need to be complicated and contrary to popular belief, it can be flexible. In fact, if you’re a small business owner working with larger businesses it will have to be flexible because most will insist that you work on their terms, not yours.

Agreeing payment terms

Many advisers say that your credit control system starts when you invoice your client.  However, there’s actually a step before that. Before you send your invoices (and preferably before you start working for your client), you need to agree payment terms and find out what it will take for you to be paid on time.

This may sound obvious, but it’s a discussion people rarely have. They spend the majority of their time talking about their products and services and almost no time at all talking about the business relationship.

For example, my standard terms are 14 days from the date of invoice. However, I have one client who will not pay until 30 days after the end of the month in which I send the invoice. And they will only pay then if I quote the purchase order number I have been given and attach a log of the hours I have worked that month.

I know this and I have agreed to these terms. I always get paid within the agreed terms so I can forecast my cash flow according to this.

There’s no need and no point sending reminder letters after 14 days have passed because no matter how hard I chase, I won’t be paid any quicker and could damage the relationship with my client if I do.

Assuming you have agreed payment terms with your client and they don’t pay on time, you need to start following up with them.

The starting point is usually a gentle reminder that your invoice is overdue and that it needs to be paid by return. It’s good practice to send a further copy of your invoice with your reminder letter to avoid the excuse that they didn’t receive it. (I’ll speak more about excuses later.)

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If this doesn’t lead to payment you need to follow up with further reminders, each one getting firmer in your demands for payment.

For example, your second letter could remind your client of your right to start charging interest on your overdue invoice and your third and final demand may threaten legal action.

Don’t just rely on writing or emailing your reminders as these are easy for your client to ignore. Pick up the phone and talk to your client. In my experience, this is by far the most effective way of getting paid because you can deal with any issues your client has there and then.

If you don’t receive payment after your final demand, be prepared to take legal action.

Now, I know what you’re thinking:

I can’t possibly take, or even threaten legal action against my client. That would be terrible for our relationship

I agree that it could make things uncomfortable (you may even lose the client) and you have to accept this. But remember, it’s not you putting the relationship at risk – it’s your client. Your priority is getting paid for the work you have done because you have a responsibility to your staff and everyone else who is relying on you. So, you must ask yourself whether these are the sort of clients you want to be working for.

Where people go wrong with their credit control procedures is that they chase and chase and get nowhere. To make your credit control system more effective, each contact with your client should get you closer to being paid.

Two golden rules

I have two golden rules when it comes to credit control. First, no clients should be exempt. Your system can be flexible, but everyone needs to be part of it. Don’t be afraid to ask for payment if you haven’t been paid within agreed terms, and follow up all the way through to taking legal action if necessary.

Second, don’t be put off by excuses and sob stories. Think in advance about the likely excuses you will hear and how you will respond to them. And remember, in most cases they are just excuses. The reasons given for not paying won’t be true.

If you find it difficult chasing slow payers for your money, consider taking on a credit controller who can do this for you. This can work wonders. By having someone who doesn’t have day to day contact with clients chase payments for you, they can take a tougher stance without worrying about compromising relationships.

Effective credit control is a skill. I know it can feel awkward asking for money, but if you want your business to be successful, it’s an essential skill you must develop. If you would like any help with this, feel free to email me at editors@businessadvice.co.uk and I would be delighted to assist.

Catch up on some of David’s recent Business Advice articles:

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ABOUT THE EXPERT

David Walker is the founder of Grid Law, a firm which first targeted the motorsport industry – advising on sponsorship deals, new contracts and building of personal brands. He has now expanded his remit to include entrepreneurs, aiding with contract law, dispute resolution and protecting and defending intellectual property rights.

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