The costs of accounts receivable
Before we look at the steps of how to collect unpaid invoices, it’s important to understand what are the true costs of late payments, which are significant. Companies will often take out business loans or use invoice factoring to improve cash flow. There is the administrative cost connected with managing accounts receivable. In addition, there’s an opportunity cost of not having the money you are owed that you could be using to grow your business.
One study in the Healthcare Financial Management Magazine found that the total cost of carrying accounts receivable is 1.82 per cent of the invoice amount at 30 days, 10.29 per cent at 60 days, 9.74 per cent at 90 days and 30.71 per cent at 120 days. These numbers show why it’s crucial to understand how to collect unpaid invoices. Learn more in What Are the True Carrying Costs of Accounts Receivable?
Stay in touch to collect your unpaid invoices
Communication is key to the collection process. As soon as an invoice is overdue, it’s time to get in touch with a reminder about paying the invoice. If you don’t receive a response, keep on emailing reminders that the invoice is overdue. Why do this? The research clearly shows that it can take several reminders to get the client to pay. One study by ezyCollect, an accounts receivable software developer, found that 59 percent of overdue invoices require three or more follow-ups before they’re paid. The study based on 213,000 invoices found that:
- 21 percent of invoices are paid after the first follow up
- 20 percent are paid after the second reminder
- 32 percent are paid after the third reminder
- 13 percent are paid after the fourth reminder
- 10 percent are paid after the fifth reminder
- 3 percent are paid after the sixth reminder.
Clearly, the more often you follow up, the sooner you will get paid. These payment reminder letters can start out with a polite tone and get more serious and forceful if you don’t get a response. The final letter is called a letter of demand. You can find a variety of free collection email and call templates online that you can customise to fit your needs. Here’s one example of free invoice collection letter templates you can use.
Next steps for debt collection
If debt collection letters for unpaid invoices are not effective, including a demand letter for unpaid invoices, you can turn the invoice over to a collection agency. A debt collection agency will follow up with the debtor to recover the outstanding payment. These agencies charge a percentage of the amount owed if they successfully collect it. Typically, this can range from 10 per cent to 35 per cent, depending on the value of the invoice. The smaller the invoice amount, the higher the commission percentage charged. This is because it can take as much time to collect a small debt as a large one. So while you might pay 10 per cent of a $50,000 invoice that is collected, you might pay 35 per cent of a $5,000 invoice after it has been received by the collection agency.
If the collection agency isn’t successful in collecting the debt, legal action is the next step in debt recovery. Many collection agencies have legal professionals on staff to follow up. You can also take legal action on yourself or hire a solicitor to take legal action. This can get expensive when you consider professional fees and filing costs, so you will want to weigh the costs with the potential benefits. Often, the costs of recovering a small debt will outweigh the benefits.
Proactive ways to avoid chasing overdue invoices
You can decrease or completely eliminate the need to chase unpaid invoices by taking proactive steps. These include implementing credit policies and procedures and using a finance solution that enables you to outsource your accounts receivable.
How to collect unpaid invoices with credit policies and procedures
One of the biggest causes of late invoice payments is not having solid credit policies in place and implementing them. According to Moula’s research, 47 per cent of SME customers expect invoice payment terms from their suppliers. When you have credit policies and procedures in place, you can take steps to decrease the risk of late payments. This begins with vetting new customers by checking credit references and reports and requiring customers to agree with your terms and conditions. You can also outline the steps you will take when payments are not received. This removes the emotional component from accounts receivable management. Find out more in How to Protect Your Business with Credit Policies and Procedures.