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The Financial Effect of Default Accounts on Businesses

Anna Burgess Yang

At some point, your business will likely have customers that fail to pay. This can happen for many reasons, from lost invoices to their own unexpected expenses. Whatever the reason, these outstanding accounts can have a negative impact on your business.

Non-paying customers can be a tricky thing to address. On the one hand, you want to receive payment for any receivables that are in default. On the other hand, being too forceful may be hard - especially if you have a relationship with your customers. 

However, you need to keep your business's needs at the forefront of your collection process. Too many unpaid invoices can lead to serious issues for your business. At a time when many small businesses are struggling, the collection of these payments may make the difference in survival. 

Let's look at some of the main ways that late payments can impact your overall business. 

Impact on Your Cash Flow

Cash flow is critical to any business. You need cash to pay for things like rent, utilities, salaries, and materials. While cash reserves can help a business through tough times, this simply is not practical for many small businesses.

If you have depleted or don't have cash reserves, you may be forced to go to a bank for a loan or tap a business line of credit. In either of these cases, you are then paying interest to borrow money while waiting for payment from your customers.

Not only do unpaid invoices affect the cash you have on hand, but they also impact the predictability of your receivables and your ability to plan. If you send out invoices and expect payment within 30 days, and some customers don't pay, then you don't have the cash you were expecting.

Impact on Your Ability to Obtain Credit

When you apply for a loan at a bank, sometimes the bank will use your accounts receivable as collateral for the loan. The bank reviews your accounts receivable aging report. If the lender notices that a lot of the accounts are severely past due or in default, you will not be able to borrow as much.

Additionally, because of the impact on your cash flow, you may have trouble paying some of your own creditors, such as suppliers. If you are unable to pay, this can jeopardize your ability to work with that supplier in the future. 

Impact on Your Accounting

If you provide goods or services on credit, your customers may be making payments to you over time. When your customers stop making payments, this has an additional impact on your balance sheet.

Accounts receivable reported on your balance sheet are expected to turn into cash within one year. Therefore, any accounts that are not collectible are overstating your assets. 

You may be forced to include a contra asset account called Allowance for Doubtful Accounts and Bad Debs Expense. In this account, you'll include the accounts receivable that you believe are uncollectible. Your balance sheet assets will be decreased, and you'll also need to report the Bad Debts Expense on your income statement.

Impact on Your Ability to Conduct Business

A final impact on your business is the time and energy involved in collecting on accounts or invoices in default. Often, you will have numerous communications with the customer during your attempts to collect. You also need to have a process in place to track your efforts.

Your efforts may include all of the following:

  1. Sending a past due letter or invoice
  2. A phone call to the customer to discuss the default
  3. Imposing late fees
  4. Additional, more stern, follow-ups
  5. Involving a debt collection agency
  6. Taking the customer to small claims court 

You need to be very careful, in all instances, to follow regulations that protect individuals when it comes to debt collection. The Fair Debt Collection Practices Act regulates how customers can be treated. 

You do have some means to reduce the number of accounts in default. You can require upfront payment, have customers complete an ACH or credit card authorization, and accept online payments. You can also set up payment plans for customers that want to pay but can't because of their circumstances.

However, in some businesses, these options are simply not feasible. If you have a lot of customers that are in default, attempts to collect can be time-consuming. You may need a resource who spends time on this. That is less time spent on the other aspects of running your business. 

Using an Outside Agency to Collect on Accounts in Default

It can be hard to chase customers who are in default. Between the multiple steps that are legally necessary, the follow-ups can be time-consuming. Not only are you expending your own resources on the effort, but taking a customer to court can incur legal costs. 

Companies that specialize in debt collection and accounts receivable management can speed up this process. Agencies have more tools at their disposal and can use persistent, repetitive efforts to collect.

Not only that but using an agency puts a degree of separation between you and the customer. You are not the one making the demand for payment. Instead, your customer is now dealing with a third party.

Since asking for money is hard for many business owners, using an outside agency can result in a more consistent approach and better collection of accounts in default.

Finding the Right Accounts Receivable Management Company

By working with an accounts receivable management company, you can separate yourself from this process and focus more on your business. An outside company has one goal: to collect on the outstanding debts for their clients.

They are more efficient and can achieve better collection results on accounts in default than your own internal efforts. You will find that an agency is able to resolve challenging payment issues quickly and professionally. This relieves your organization of the burden, maintains the relationship with your customers, and increases your bottom line by receiving the payments you were expecting.

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