Do You Know Which Customers Are Likely to Pay Late?
Recognizing Scenarios that Contribute to Past Due Receivables Is the First Step Towards Remediation
In every accounts receivable (AR) portfolio there are customers that almost always pay on time, other customers that pay within a reasonable proximity of the due date, and those that pay consistently slow. It usually only takes about six months to figure out the segment into which a new business customer will fall. Once each customer’s payment proclivities are known, assigning appropriate monitoring and collection strategies is easily done, thereby ensuring adequate collection coverage.
For the most part, business customers are fairly consistent in terms of their payment patterns. However, over the course of a year there will be events and situations that will cause these patterns to change. Do you remember how the onset of Covid-19 changed the payment patterns of most companies? During the course of a more normal year, upwards of 20 percent of your customers will change their payment patterns. A large number of these will be incremental, and many of those will eventually return to the norm. These situations are seldom problematic.
Difficulties arise when an event or situation causes significant changes in customer payment patterns. The good news is that many of the events and situations that result in slowing payment are fairly easy to recognize. Before discussing them, however, a few words about the red flag that is raised when a customer’s payments become irregular is warranted.
Beware Irregular Payments
How a customer is currently paying you is the best predictor of how the customer will pay you in the future. Obviously, when payments begin slowing, you need to take action. Tracking average payment times will tell you when this is happening.
Many times, however, customer payments become irregular before a consistently slowing trend is apparent. For example, one slow payment may be followed by a couple on time payments, followed by a very slow payment, then a not so slow payment, and then several on time payments. There is no trend there, but from a statistical perspective, increases in the standard deviation of payment times provide a huge red flag.
Such irregular payment patterns are indicative of cash flow difficulties — the customer is trying to pay promptly, but because of cash constraints is not able to do so. This is especially true in the case of small business customers, who will do everything they can to keep paying their suppliers and vendors, including tapping out their personal credit, until the bottom falls out. Irregular payments are a clear warning sign that default may be around the corner.
Here’s what to do with any customer whose payments become irregular:
Tighten up the collection strategy being used with the customer. In other words begin your collection efforts sooner and accelerate the escalation process by increasing urgency and calling more frequently.
Re-evaluate the customer’s creditworthiness and reduce their credit limit as appropriate.
Hold all new orders pending payment of any past due items.
Offer an early payment discount and begin charging late fees. This is a bit of a carrot and stick approach, but the idea is to make it worth the customer’s while to pay you promptly. The ultimate goal is to get your customer to pay you before they pay other vendors.
Offer the customer other payment options. Check payments are still the norm for many businesses, but electronic payments via ACH and virtual cards are becoming increasingly popular. Letting customers pay in their preferred mode generally accelerates the payment cycle.
If possible, move the customer from an open terms account to payment via a credit card at the point of sale, not 30 or 60 days later. A one or two percent discount can be a catalyst, and the cost will be offset by letting the card issuer pick up the risk along with the elimination of all collection expenses on your account. If you have a number of small business customers that make small purchases from time to time, moving them to a card purchase is a great way to reduce your risk and collection burden.
A similar option involves bringing a third-party finance company into the transaction. There are a variety of forms of invoice finance, but in essence all involve the transfer of ownership of the invoice to the finance company, which pays the supplier a discounted amount within days of the invoice issuance and then collects the customers payment at a later date.
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Eight More Situations That Often Lead to Slow Payments
Mergers and Acquisitions
Whenever a customer is acquired, or acquires another entity, the dynamics of your firm’s relationship with that customer will change. In either case, there has to be the eventual consolidation of the two company’s AR portfolios. More often than not, this does not go smoothly. Should the acquired firm’s accounts payable (AP) staff has been dismissed, it becomes extremely difficult to resolve pre-existing payment disputes. Knowing that juncture may come, a focused effort should be made, as soon as a merger or acquisition is announced, to get your AR with the former entities cleared up (preferably with a payment, of course). In addition, you will now be dealing with what is essentially a new entity, even if your customer’s staff remains in place. It is therefore important to update your credit evaluation of this customer when the M&A occurs as well as over subsequent financial reporting periods.
Layoffs
When a business customer announces layoffs, it’s important to find out why. Is it due to an economic recession? In that case the company is likely taking steps that will protect their cash flow. Are the layoffs the result of over-expassion? Getting rid of corporate bloat should be good for cash flow. Has the company experienced a down turn? In that case layoffs can be more problematic. Should the company end up understaffed, getting payments approved could prove more difficult on top of the customer’s financial struggles. Moreover, an understaffed AP department will have trouble finding the time to resolve disputes and other problems, which could delay payments. No matter the cause of the layoffs, it remains imperative that you maintain close contact with your customer’s AP team so your invoices don't get lost in the shuffle. Even so, customer layoffs are a cause for concern, and understanding the cause will drive both your evaluation of the customer’s credit-worthiness and your collection strategy.
Cyber-Attacks
Most small businesses do not survive a cyber-attack. Medium-sized businesses tend to fare better, but a substantial number end up seeking bankruptcy protection to survive. Large enterprises are generally better prepared and have more resources for surviving a cyber-attack, but still need to be watched closely. If the attack is in the form of a data breach, your customer will likely remain operational in the short term — the long term risk is lawsuits over the breach. A cyber-attack that takes down a company’s systems has a more immediate effect. How quickly your customer is able to recover from the attack will largely determine their ability to get back on their feet. Larger organizations that have built redundancy into their systems will fare best. Once you hear that a customer has suffered a cyber-attack you need to evaluate their ability to recover — ask for help from your IT staff to make this assessment.
Natural Disasters
These follow a similar pattern to a cyber-attack that impacts a business’ ability to operate. The questions you should ask center around how much damage they incurred and how long it will take for them to resume normal operations. You should also find out if they have business interruption insurance. Once you know all the facts, you will want to work with your customer to come up with a payment plan to which they can adhere.
New Locations
Major moves can be stressful for any business, whether it involves a new headquarters location, a new warehouse, or even setting up a new back-office shared services center. There are a lot of logistics that go into making any of these moves, so it is not uncommon for unforeseen problems to arise. When you find out a customer is making a move, you should make sure the lines of communication are open before and after the move so you can monitor it and quickly address any issues that might arise and affect their payments to your company.
Changes in Behavior
When there is a long-standing relationship with a customer, any variation from the normal course of business should be investigated. Changes in ordering patterns or responsiveness to your inquiries are often precursors to payment defaults. Is your customer ordering less because they are trying another vendor, or is their business slowing down? Have they begun raising multiple disputes? This could be either a customer satisfaction problem, or a ploy by your customer to slow down payments. Whatever the case, open communication lines, including with your own sales team, will go a long way towards identifying the root cause and remediating the situation.
Personal Problems
When dealing with small businesses, any event that affects the health and well-being of the owner or key staff members can affect the normal operations of your customer. If your primary contact or the company principals are struggling with personal problems, it can be difficult to get them to address payment issues, as well as have a negative impact on their business. This is one reason it is important to always have a back-up contact for all your customers. If you run into this type of situation, you probably will need to follow-up more frequently that usual because your customer is going to be distracted. Also, keep in mind that you are dealing with human beings who deserves empathy.
Unresponsiveness
When a customer stops responding, look out. If your contact is avoiding you, it may only be because they are really busy or no longer works there. That’s why it is essential that on your initial collection calls (as well as on the credit application you have new accounts fill out), you find out who else you can contact in your customer’s payment heirarchy. However, if none of your customer contacts is responding or giving you satisfaction, then it is time to turn the debt over to a collection agency or attorney.
In Summary . . .
The dynamics of accounts receivable management demand vigilance and adaptability. By monitoring and responding to irregular payment patterns, businesses can proactively mitigate risks and ensure better cash flow stability. Employing a multi-faceted approach—tightening collection strategies, offering varied payment options, and potentially involving third-party financing—can significantly reduce the impact of slow or irregular payments. These strategies, when applied consistently, help safeguard your revenue and maintain strong customer relationships.
Furthermore, recognizing and responding to key events that influence customer payment behavior is crucial for maintaining the financial health of your AR. Whether dealing with mergers, layoffs, cyber-attacks, or natural disasters, understanding the underlying causes and maintaining open lines of communication with your customers will help you navigate these challenges effectively. By staying informed and flexible, you can better manage you AR portfolio to ensure stability and long-term performance.