How to collect outstanding payments: Best practices for small businesses

Late payments are more than just frustrating—they can damage a small business. In fact, 82% of small businesses fail due to mismanaged cash flow.

Businesses need a steady stream of income, and when customers are late on invoices, it can throw a major wrench into operations. You must pay lenders and employees on time. If you don’t have the funds to satisfy your obligations, you risk expensive late fees, compounding interest, labor lawsuits, and a tarnished reputation.

It’s crucial that your customers make timely payments, but what happens when they don’t? If you value their business, you’ll need to be cautious and ensure your attempt to collect payment doesn’t come off aggressive.

2020 has seen a 32% increase in the number of businesses that could not pay suppliers due to customers’ late payments, says a recent Atradius survey. To avoid adding to the statistic, those with delinquent accounts must know that you’re serious.

If you’re not sure how to ask customers to settle an invoice professionally, use this guide to learn how to collect outstanding payments. Plus, learn how to handle your accounts receivable, so you can better manage cash flow and keep your business in the black.

The importance of getting paid

Companies need money to keep operations in swing, yet Fundbox found that the average small business has $84,000 in unpaid invoices.

Too many entrepreneurs let overdue invoices slide for a couple of reasons. It might be that they’re too busy to track their accounts receivable and have a hard time staying on top of who owes what. Or maybe they’re nervous about confronting a long-standing customer out of fear they won’t return.

Whatever your case may be, it’s critical that you do not allow outstanding payments to fall to the wayside.

How do receivables impact cash flow?

Accounts receivable (AR) is the dollar amount of credit sales that you don’t collect in cash . You must account for the value in your cash flow statement (CSF). A cash flow statement summarizes all the cash and cash equivalents entering and leaving the business. And it’s essential for understanding your company’s financial footing.

When AR decreases, it implies more cash has entered the business from customers who have paid off their credit accounts. However, when AR increases from one accounting cycle to the next, you must deduct the amount from net sales because it represents revenue, not cash.

Outstanding payments add to your AR balance and introduce cash flow challenges. And these challenges can extend beyond your bank account. 56% of business owners agree that the emotional impact of cash flow problems is highly consequential.

How is value lost on money owed?

Outstanding payments can add stress and impede your ability to repay lenders, suppliers, rent, bills, and employees. And as time goes by, the money your customers owe loses value. Some statistics suggest that after 60 days, an overdue invoice may only be worth 60% of its initial value. After 90 days, the value may drop as low as 20%.

Every day without a dollar in your hands is a day you’re not using working capital to your advantage, decreasing operational efficiency.

What effects do late payments have on small businesses?

Late-paying customers can be annoying, but beyond the surface-level frustration, overdue invoices can significantly impact business operations. A 2017 Fundbox survey on the trickle-down effect of late or unpaid invoices found:

• 79% of small business owners can’t pay themselves.
• 23% can’t hire new employees.
• 23% can’t invest in new equipment.
• 20% cease marketing efforts.
• 17% can’t build inventory.

The bottom line: Small businesses need to collect outstanding payments promptly if they want to maintain cash flow and improve their chances of success.

How to collect outstanding payments

What should you do when an invoice is past due? Follow these five steps to collect outstanding payments, so your small business can get paid sooner.

Step 1: Follow up

We all make mistakes from time to time. It’s important to remember that your customers are human, too. They might have had a moment of forgetfulness or misplaced their bill. So the first step to collecting an overdue payment is to reach out with a friendly reminder.

Ideally, they should have received communication reminding them of their upcoming due date. But you’ll need to send a follow-up email once a customer misses a payment. Don’t assume your customer will get around to paying you based on previous communication. Every day that goes by is more than just missed cash flow. It’s also value lost.

When following up on missed payments , make sure your message is polite and courteous but firm and resolute. It’s a good idea to create a standard nonpayment form or email template that you can send customers when these situations arise. They’ll be less likely to take a standardized letter personally. And a standard letter can help cut down on the administrative tasks involved in the collections process.

Give the customer an option to contact you in case there’s an issue on their end. Then clearly define your next steps should you not hear back. If they don’t reply or pay within 30 days, it may be time to give them a call. Phone calls can be harder to ignore than emails. And a call may help you get to the heart of the reason why they’re not paying their outstanding amount.

Step 2: Figure out the problem

Your goal is to identify the holdup and how you can get paid. Maybe your customer forgot, maybe they hit a rough patch, or maybe they’re backlogged with administrative burdens. Once you understand the problem, you and the customer can determine a payment plan that works for both parties.

If your customer is experiencing a hardship, you might have to evaluate how likely they are to recover and how much money you can reasonably recoup. For example, are there external circumstances impacting their ability to pay?

The economy has taken hits due to COVID-19, and small businesses have taken the brunt of them. As of June 2020, an average of 43% of the total value of B2B credit sales was overdue, according to the Atradius survey. And many companies are scrambling to collect unpaid invoices.

Some businesses have responded by extending their repayment terms, while others are adapting their payment policies. Strategize ways to evolve so that your small business can continue to operate.

Step 3: Provide a solution

Once you assess the overdue account’s value and how much it’s worth to your business, you can find a repayment solution. Installment plans are the best option to get the complete amount due back over time. For example, if one of your clients owes $5,000, you might allow them to make $1,000 payments for five months with or without interest.

If your small business can’t handle that hit to cash flow, you could offer the customer a partial-payment agreement. In this case, you might accept $3,000 in lieu of the full $5,000. You’d take a hit, but this option may help you get as much of the balance due as soon as possible.

Step 4: Take legal action

Unfortunately, some customers still won’t budge after doing all that you can to accommodate them. At this point, you may consider asking a lawyer to assist with the outstanding payment collection.

A “demand letter” is an official document that pressures the late party with legal action if they don’t pay their debt. You can ask your lawyer to draft a demand letter and mail it to your customer past due to let them know you’re serious.

Step 5: Escalate the issue

If you’ve had no luck collecting an outstanding payment, talk to a lawyer about your options. They should be able to advise you on the likelihood of winning your case in court. They can also estimate the fees they would charge to represent your case.

Going to court can be expensive, so if you don’t want to get involved with legal proceedings, you may hire a collections agency. When do you send an outstanding payment to collections? It depends, but the general rule suggests waiting until the account is “long overdue,” or 90 days late. More businesses may be considering this option. The Atradius survey found that the total value of long overdue invoices rose to 16% in 2020.

Every agency is different, but most will take a percentage of the money recovered on your behalf. According to the Better Business Bureau , they can retain 50% or more of the amount due. Small business owners can also sell unpaid invoices to a factoring agency at a discounted rate. Selling to an agency wipes your hands clean of the collection process. In either circumstance, it’s likely that you’ll only collect a portion of the total amount due.

It’s in your interest to do everything possible to avoid this situation from impacting your bottom line. You can help prevent payments from becoming past due by implementing a streamlined process that mitigates the risk of late invoice payment.

Tips for preventing late payments

Prevention is always the best strategy. Rather than scrambling to manage cash flow due to late-paying customers, use these tips to reduce the risk of payment problems from the get-go.

Track unpaid invoices

Use your accounting software to monitor your accounts receivable regularly. After all, you can’t collect outstanding payments if you don’t know you have them. Monitoring your accounts will become increasingly important as your business grows and more customers pay on credit. So prioritize these delinquencies early on.

Create a policy

Your customers need to know what you expect of them, so include a formal document with your contracts that establishes your payment policies. Your policy should clearly indicate payment terms. Define how much time a customer has to pay an invoice and what happens if they don’t pay by the due date.

Some businesses may charge interest or late fees on an outstanding balance. But defining your policies upfront can empower you if you need to send a reminder or reiterate your payment terms down the road.

You should also develop a system for following up on missed payments. You might follow up a few days after the payment is late or weekly until you collect the debt. Determine what schedule works best for your business, then stick to it.

Request payment upfront

You can reduce the risk of late payment or nonpayment by requesting partial payment upfront. Even partial payments can help maintain positive cash flow and offset some of the damage late payments cause. The percentage depends on your industry and what you’re offering. Some companies may request 50% down, while others ask for an upfront payment in full.

If a customer presses back against your terms, politely explain your policy. Then direct them to positive testimonials from past customers who were satisfied with the work you delivered.

Streamline payment methods

In some cases, a customer may be late on a bill because your payment options are inconvenient. Can you expand your acceptable payment methods? Consider allowing customers to settle with a credit card or online payment in addition to cash or a check. Accepting more payment methods may help you remedy delinquent accounts more quickly.

Set up recurring payments

If you want customers to pay bills faster, you should make the payment process as simple as possible. Reduce the risk of overdue payment with automated payment options. Small businesses with regular accounts can set up recurring credit card payments or direct deposits.

Automate your invoicing

Automatic invoicing may help you avoid nonpayment issues. Plus, it saves paper and postal expenses, and it’s much faster than sending an invoice through the mail. Sending an automated invoice after you deliver the product or service can speed up payments because it’ll be fresh in the customer’s mind.

With the right accounting software, automatic invoices may also come with timely payment reminders. This feature can save you the time and hassle of keeping up with various due dates and outstanding invoices. You can also include a link to an online payment system so your customer can conveniently settle their bill.

Collect outstanding payments with QuickBooks

QuickBooks can help small businesses get paid faste  with comprehensive accounting and invoicing solutions. Get more time back in your day with customizable invoice templates, invoice letters for payments past due, built-in payment processing, automated reminders, and more. The right accounting system can help you manage your books in one place.