Collections Policy

Strategies for a More Effective Collections Policy

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Collections Policy Definition

A collections policy is a set of guidelines that govern the accounts receivable team’s procedures and helps to create a more consistent, systematic treatment strategy. Many companies may have their collections policy as part of their credit policy, but the collections policy is worth considering on its own.

The business landscape across many industries has been changing rapidly, and as a result, collections policies and procedures can become outdated. Periodically review guidelines and procedures so that they change with the times. In light of current economic conditions, businesses should consider a nuanced approach to collections management. Revising collections strategies to acknowledge an uncertain environment and to create more transparency for both customers and collections team members is crucial for protecting accounts receivable, maintaining strong customer relationships, and motivating employees.

Goals of a Collections Policy

The purpose of having a collections policy in place is simple – to protect accounts receivable. Efficiently collecting payment on current accounts receivable and past-due accounts while maintaining positive customer relationships is the main goal of the collections department.

On a practical level, businesses should be proactive with collections and transparent regarding goals and expectations. A thorough collections policy should embody these goals and expectations. Common goals of collections departments include:

Collections Policy and Procedures

The set of procedures you define for your collections team to follow will be the core component of your company’s collections policy. They should be practiced consistently and should aim to apply to all customers – but should also be flexible when necessary.

This step-by-step process begins when an account first becomes past due. The process needs to continue until payment is collected, turned over to a third-party collections agency, or written off as bad debt. The policy should include account prioritization and clearly defined timeframes for contacting customers and escalating issues, strategies to be used, and tone and behavior to be exhibited throughout interactions with customers and internal departments.

An important consideration to keep in mind when defining your company’s collections procedures is the size of your organization. Smaller companies often have tighter profit margins and can be catastrophically impacted by delinquent accounts. These risks should be reflected in the steps of your collections process, such as by tightening timelines of customer contact and escalation to senior management, in order to closely guard accounts receivable and optimize your cash flow. On the other hand, larger companies that have access to greater sources of capital may implement a more relaxed collections policy, concentrating more on the customer relationship and future business than on shorter timeframes for collecting payment.

Below are sample guidelines to help you build out your company’s collections process. Timelines and strategies can be customized to reflect different levels of risk with respect to both your company and your customers.

1. When to Contact Customers

  • Days 1-3 past due: Confirm invoice was sent, confirm there are no disputes, and send automated email reminder including account statement.
  • Days 31-45 past due: Mail letter on company letterhead stating payment is now 30 days late. Apply late fees to account.
  • Days 4 -7 past due: Contact customer by phone and/or email attempting to secure payment. Ensure any discrepancies or disputes have been resolved.
  • Days 46-60 past due: Begin calling and emailing customer every 3-5 business days. Place account on credit hold and notify sales representative and customer of credit hold.
  • Days 8-14 past due: Send second automated email and follow up with a professional, scripted phone call. Notify sales representative that payment is now one week late.
  • Days 61-90 past due: Notify senior management and prepare to send account to collections agency and/or legal counsel and/or write off as bad debt.
  • Days 15-30 past due: Send third automated email stating account will incur late fees after 30 days. Follow up with a phone call to confirm receipt and remind customer of late fees.
 

2. How to Handle Disputes

A comprehensive collections policy should include guidelines on how disputes and discrepancies should be handled. Before initial contact with a customer, the collections professional should ensure that any internal issues are cleared up. These might include unapplied checks, unused credits, or any special terms offered by the sales representative but not applied to the account. If a dispute arises during interactions with the customer, handle it quickly to avoid slowing down the receivables process. For example, if you wait a week to send the customer a corrected bill, you’ve just put off getting paid by a week.

3. When to Send Accounts to Collections Agencies

When all internal means of collecting on a past-due account have been exhausted, some companies choose to turn the delinquent account over to a third-party collections agency. A collections agency is a company used to recover funds that are past due or from accounts that are in default. This step in a collections process usually occurs when the account is 60 or more days past due.

There are several factors that influence a company’s decision to turn past-due accounts over to a collections agency. One factor is the company’s risk tolerance for bad debt. If positive cash flow would not be greatly impacted by a certain level of bad debt, a company may choose not to outsource collections efforts. On the other hand, a company with tighter profit margins would likely be more risk averse and may set forth in their collections policy the transfer of past-due accounts to a collections agency at a designated number of days past due.

4. When to Write Off Bad Debt

If it has been determined by the collections team, in congruence with the collections policy, that the debt has become worthless (because it can’t be collected), then it can be written off. Writing it off means adjusting your books by removing it from the accounts receivable balance so that it is not represented in the total amount of your current accounts.

Managing Exceptions to Your Collections Policy

Of course, there are always exceptions to established procedures, even with a collections policy. Your policy should be structured and consistent but also flexible, so it can adapt to changing times and uncertain environments.

Negotiating Terms

Customers who are aware of their inability to make timely payments may want to renegotiate terms or arrange a payment plan. However, extending terms disrupts your cash flow. Perhaps the customer is offered an extended payment plan, but with the extension they agree to forfeit discounts. If payment is still late after renegotiating terms, the customer forfeits the right to renegotiate for an extended period.

Measurement of Your Collections Policy

Once goals are established and procedures best practices are defined, it's important to identify metrics to help measure and evaluate the effectiveness of your collections policy. Regularly monitoring performance helps identify process issues that could be slowing down collections.

The metrics should align with the goals you have set for your collections policy, be consistent, and aim to improve the quality of work performed by your collections professionals.

As mentioned earlier in the context of setting goals, (DSO) is a common metric used in the collections process. DSO is widely used as an overall measure of accounts receivable relative to credit sales. If your goal was to keep your DSO below a certain number, did you achieve it? If not, what can you do to get there? If you find that the targets are not being hit, consider adjusting your collections policy accordingly.

As an added measure, by calculating DSO for those customers with extended terms and comparing them to all other customers, you can better determine the impact of extended terms on your receivables performance. Further, the receivable balance for customers with extended terms should be closely monitored to provide insight into any trends and as a point of comparison with standard-term customers. This will help determine whether your extended-term approvals are being honored, and whether your monitoring and collection efforts are effective.

As a reminder, extended terms are a customer courtesy. In some cases, it is a tactic to preserve sales, while in others the hope is for increased sales. With this in mind, the profits generated by extended-term sales should be tracked at least quarterly as well as year to year, and perhaps even more frequently during times of financial uncertainty.

Benefits of Measurement

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