How to collect (and reduce losses from) bad debts

Whether you work in practice or in business, dealing with late debtors can be a sensitive and tricky task. Spotting the warning signs – and acting decisively – can make all the difference, says Roger Mendelson

No-one is in a better position to assess the financial strength of a client or employer than the accountant. The accountant really has inside knowledge, to which other creditors would love to have access. That is no guarantee that a business will always be in a position to pay debts, including to in-house staff, or creditors.

If a business sets itself up on the presumption that one day it may have to sue its customers, then it will ensure that the business is in the strongest position possible to obtain judgment, and to then enforce that judgment. Just because you are able to sue does not mean that in most cases you will need to. However, if you are able to sue and have a clear legal enforcement path for that judgment, the chances are that your defaulting customer will pay, because they will be made aware of the consequences.

Set up properly

The fundamental building block is to ensure that you set yourself or your client up so that the individual who provides you with instructions for his entities is personally liable for payment of all accounts. This is easy to enforce through completion of a carefully worded new client form, a critical step in assigning responsibility for payments. The form would detail all entities, including all individuals, who are covered by the instructions.

Invariably your accounts for the various entities will be invoiced to those entities, and the entities will be the parties legally bound to pay. However, if there is a default, the best party to sue will be the individual who provides the instructions. If you are acting for a group of companies, ensure that the form is completed by the company with the major assets.

Trading terms

The form is the best place to incorporate your business trading terms. If they are outlined here, and are signed by the individual it will be very difficult for a customer to make any argument that they are not legally bound by them.

The trading terms will incorporate certain provisions such as:

  • The obligation on the individual to pay accounts for all entities within his group
  • Provide for no right of offsets of claims against invoices owing
  • Allow for penalty interest to be added to overdue accounts
  • And importantly, provide that in the event of default, the customer is to be liable for legal costs on the indemnity basis, and all commission payable to a collection agency.

I also recommend that you retain a lien over books and records in relation to all unpaid accounts, and have the right to retain tax refunds to offset against overdue accounts. Under the consumer legislation, there are now certain minimum warranty clauses that must also be legally incorporated.

Invoicing

Invoices issued to trusts, whether discretionary, unit, estates or superannuation funds, should always be addressed to the trustee and not to the fund itself. The reason is that a trust is not a legal entity, and therefore cannot be sued. Legal action for unpaid accounts must always be taken out against the trustee, who will then have recourse to the trust assets. Smaller businesses often face the problem that particular business managers take a proprietal approach to ‘their customers’ and interfere in the billings and collection process. This is a recipe for disaster.

Debt responsibility

Responsibility for the credit and collections function must be passed to one person who takes responsibility and is fully empowered to handle the function. This does not mean that the person must actually handle the work, but that responsibility for it is measured on the collections performance (a ‘collection officer’).

A common mistake made is to bill when the job is complete, rather than interim billing, not only is cash flow improved, but the opportunity arises to assess the payment history of the customer.

I am often surprised at the number of examples my business, Prushka, comes across of accounting clients being in significant arrears but practices continuing to carry out further work. This is often the situation where there is an overly proprietal partner who is egged on by his client with promises of future payments. Problems like this will not occur if the credit officer is the one person responsible for the whole credit function.

Issuing statements

Sending multiple statements is sending the message to your customer that you are not serious about collecting money. Ideally, there should be no more than the initial invoice, statement or letter at 30 days, followed by a phone call. The phone call will ascertain if there is any reason why the account is unpaid, and will be followed-up by obtaining a firm promise for payment.

It is at this point that potential problem accounts will be isolated. For example, if there is a promise to pay the account within seven days and this is not adhered to, no promise is made to pay at all or if concerns are raised about the service provided, further action is really called for at that point.

Don’t ignore the signs

Professional practices have a reservation that the general business community does not, and that is a concern that ‘if we come down too heavy’ we will lose the client. This is a compelling reason why frontline people who deal with the clients should not be involved in collection and credit decisions.

If a client is suffering from cash flow problems, use your special knowledge of the client’s affairs to make a decision as to whether or not your fees are at risk. If they are, obtain security to cover them, such as guarantees from the directors of the company.

The warning signs for potential bad debts are really the obvious: broken or bounced cheques, post-dated cheques, a sense of confusion within the client’s accounts department, statutory demands being served and supplies being cut.

There is often a noble tendency to keep working with clients who are suffering financial problems. There is nothing wrong with this, and indeed, it is an integral role of an accountant to help such clients. However, the interests of your business must always take priority and there is a line that should never be crossed.

Don’t hang on 

Accountants tend to hang on to overdue accounts for far too long, usually due to a sense of inertia as well as clinging to the forlorn hope that ‘if I wait long enough, it will come good’.

The credit officer must set up and monitor the collections process, which involves a set of actions to be taken at defined intervals. Each step taken must be a step forward (ie harsher than the previous step) and the accounts must be on a journey to outsourcing at around 90 days. This would obviously exclude accounts where payment is being made by instalments on a regular basis, or where there is a clear payout in the future, such as a significant tax refund coming.

Call in a collector

There is only so much your business can do in-house to collect accounts from recalcitrant clients. Those over 90 days should be referred to an external collection agency. Only use an agency which operates on the no recovery - no charge basis. To allow them to be effective, provide them with a copy of the outstanding invoices and a copy of the form, as well as current contact information, particularly a phone number and email address of the customer.

There are a percentage of overdue accounts that will only be paid if the debtor is sued. In our experience, it is surprisingly low (approximately one percent of accounts referred to us proceed to legal action).

This is where the initial client set-up is important. If the customer is ‘sue-able’, then the chances of it being settled in full are high.

For accounting debts that do proceed to legal action, what the collection agency or lawyer would look for is a legal enforcement path. For individuals, this will be details of a regular job or assets in their name, such as equity in a house. For companies and trusts, it will be the existence of sufficient assets held in their name that will prompt them to take steps to avoid being liquidated.

Roger Mendelson is CEO of debt recovery business Prushka, principal of Mendelsons Lawyers and the author of The Ten Mistakes Businesses Make and How to Avoid Them and Business Survival.

Source:  Institute of Chartered Accountants, Australia, publication Charter-August Issue – Volume 84-Issue 7

Accordingly, we recommend if you are based in Australia that you should contact Mendelsons Lawyer if you are experiencing debt collection difficulties and their website contact details are :- www.prushka.com.au

If you are based in Thailand, we strongly recommend that you contact our legal team which includes a strong litigation division.