The expression “Cash is king” should be the creed for every financial director or small business owner, as without cash even highly profitable businesses can fail. Getting paid on time is undoubtedly one of the biggest problems facing businesses, as without cash a business cannot pay staff, suppliers, or taxes.

Late payment of invoices eats into profits and the longer a debt remains unpaid the greater the risk that it will never be paid.

So how can you ensure your business is paid on time and reduce your level of bad debt?

Get Your Contracts Right

Make sure that for every sale you make you have either a specific comprehensive contract, or a written order attached to your standard “terms and conditions”.

Terms and conditions – sometimes known as terms of trade – are the terms of the contract between you and your customers. They’re designed to protect your rights, limit your liabilities and provide you with some security when you sell your goods or provide a service.

Many businesses supply goods and services on the basis of informal arrangements, and often disputes arise from miscommunications that could have been avoided if there had been clearly written terms and conditions from the start.

It’s important to get your terms and conditions right. If they’re inadequate, it can be difficult to pursue or prevent bad debt. You should consult a solicitor when drafting your standard terms and conditions.

Your terms and conditions should cover (amongst others):

• payment terms – if you don’t agree a credit period with your customers the law sets a default period of 30 days,
• right to charge interest on late payments and claim compensation for debt-recovery costs,
• arrangements for supply of good or services,
• quality of goods or services and any warranty/guarantee,
• retention of title – ensuring you retain ownership of goods supplied until they are paid for.

You should make your customer aware of your terms and conditions before providing them with goods or services. Ideally, where possible, ask them to accept the terms and conditions in writing, this could be as part of their purchase order or as part of your contract. Sort out any problems they have with your goods or service and get some form of formal acceptance from your customer before you raise an invoice. Include your terms and conditions on each invoice that you raise.

Credit Checking

We all know that when you’re signing up a new client that you’ve worked hard to win, it can be very tempting to skip credit checking – after all it’d be terrible to lose the new customer by asking them too many questions wouldn’t it?

However, extending credit in this way can leave you exposed to the risk of not being paid. Conducting credit checks on new and existing customers can greatly reduce your vulnerability.

It’s a good idea to ask every new customer to complete a credit application (or trading application) form. This should include:

• full name of the customers business and whether it trades under a different name,
• registration number if it’s a limited company,
• how much credit is being asked for,
• full details of the contact for payment queries,
• delivery and invoice address if different,
• bank and bank account details,
• at least two trade references,
• request for consent to obtain bank and credit references,
• details of who owns – and who runs – the business.

How to credit check your customers

The key ways of checking a costumer’s credit worthiness include:

• checking bank references,
• checking your costumer’s payment record with some of their other suppliers – make sure that you, not your customer, choose which ones to approach in order to get an independent view,
• paying for an online credit rating from a credit reference agency,
• looking at an existing costumer’s payment history,
• getting feedback from your sales team and others who have contact with the customer,
• checking a limited company’s accounts at Companies House,
• searching the Register of Judgments Orders and Fines – held at Registry Trust Ltd,
• checking with the Insolvency Service.

Managing Credit Risk

There are a number of steps you can take to encourage customers to pay you promptly. These will boost your cashflow and reduce the potential for bad debts.

You should always try to get staged payments agreed, whereby you receive an advance before supplying goods or services, with further payments at key milestones. You then give them your normal credit terms on the balance. Or you could offer customers a discount for paying within the credit period.

Alternatively, you could arrange for funds to be held in escrow with a third party, such as a bank or solicitor, until payment is due.

The contract terms might be “one-third payment on contract, balance on satisfactory completion”. The escrow holder will only release the balance on the written instructions of the purchaser or an agreed arbitrator.

Other methods of reducing your late payment risk include using:

Third-party guarantees – a legally binding agreement by a third party that they will pay if your customer does not.

Credit insurance – covering you if you have a bad debt because your customer goes into insolvency.

Factoring – where a third party gives you an advance on a proportion of your invoice and collects the debt from your customer.

Invoice discounting – a similar system to debt factoring, where a third party pays you an advance on your invoices, but you do all the debt collection and credit control.

Automated payment systems, such as Direct Debits, Standing Orders, BACS or CHAPS – these will provide payment certainty and prevent the risks associated with bounced, missing or lost cheques.

Legal expenses insurance – this covers the costs of recovering debts though the courts.

Collecting the Cash

While it’s frustrating to have to spend your time chasing debts, rather than working on your business, it’s important to keep your cool and be professional. It will be easier to get the matter resolved if you remain professional and don’t let tempers flair.

Firstly make sure that you get a signed delivery note, or acceptance in writing from the client before invoicing, then they can not refuse to pay on the basis that the work is undelivered, unfinished or not to specification. If for any reason they correctly identify any outstanding work get it sorted quickly and before invoicing them.

Once a debt is overdue start with a friendly call to your contact and the contact you were given for payment queries, make them aware of the situation and politely ask for an explanation. A polite letter drawing attention to the invoice (include a copy of the invoice) should be sent too.

If after a further seven days payment is still overdue contact them again and remind them payment is overdue, you may like to draw their attention to the Late Payment Act 1998 and your right to charge interest on late payments, you can now either tell them you are adding interest or offer a further seven days before you will charge interest.

If the debt remains outstanding after that it is time to write to them with a final deadline giving them a further seven days to settle, after which you will begin legal action.

If you do need to take them to court make sure you have all the relevant paperwork in order, for claims under £5,000 you can handle it yourself through the Small Claims Court (if you do use a solicitor you can not claim their costs) or for higher amounts up to £15,000 it will be the local county court, amounts over £15,000 are handled by the High Court. For anything over £5,000, consult a solicitor as soon as possible.

Many businesses feel uncomfortable chasing their clients for payment often saying “but if I upset them by chasing them for payment they might not use me again”, true they might not if you’re rude, but if you handle it in a polite professional manor they are unlikely to be offended and if they are and they continue not to pay you, then hard as it may be to admit it you are almost certainly better off without them as a customer.

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