Compliance Essential for Effective Accounts Receivable Management

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The essential function of every accounts receivable department is collecting payments owed the company. Receiving money due, in full and on time, for goods or services provided is crucial to the long-term success of every business. Late payments and bad debts can negatively affect cash flow and diminish a firm's liquidity. According to some estimates, one out of five small business failures is due primarily to bad debt.

An effective collections plan can reduce business-busting delinquencies. The plan should comprise a regularly updated system that flags overdue accounts, a set of internal procedures to handle slow-paying customers, and a process by which managers receive regular updates that list slow-paying customers. As with any other business process, the collections plan should be regularly reviewed for needed improvements.

It's important to act quickly to pursue overdue accounts. The longer a debt remains unpaid, the more likely its ultimate delinquency becomes. Any account more than 60 days past due requires immediate attention. According to the Commercial Collection Agency Association, nearly 27 percent of accounts that are three months past due, 44 percent of accounts six months late, and almost 75 percent of accounts 12 months overdue will never be collected.

These sobering probabilities point to the importance of acting quickly and effectively in pursuing overdue debts. But the accounts receivable department must conduct collections activity in accordance with all pertinent federal and state laws, or it may face financial consequences that cost the business even more than bad debts would. Government agencies can levy significant non-compliance fines, and debtors who sue for libel or harassment can sometimes collect more in damages than they owed in the first place. In seeking payment on delinquent accounts, accounts receivable collectors must comply with federal laws governing collection practices including the Federal Trade Commission Act and the Fair Debt Collection Practices Act. The Federal Trade Commission (FTC) is the federal government agency that oversees compliance with collections laws. The FTC site offers pamphlets and other resources that can help guide a company's compliance efforts (See www.ftc.gov).

Many states also have their own laws governing collections. A local attorney should be able to clarify any pertinent regulations. Trade associations may also be able to provide some basic guidance.

Some common-sense best practices will not only help prevent late payments and bad debts in the first place, but will stand the business in better stead to collect legally and effectively if such activity becomes necessary.

First of all, the company should perform credit checks on new customers. Once a customer has been approved for credit, the company should insist on an agreement in writing. In the event of a future collection dispute, a signed agreement will make the company's case much stronger. A purchase order or contract should detail how much a client will owe and when it will be due. Any changes should be reflected in writing.

Proper invoicing is vital. Many payment delays occur because of simple errors, such as sending an invoice to the wrong person. It is particularly important to explain terms clearly. Terms outline how the company expects to receive payment, and what interest or penalties will be charged for late payment. These terms must be stated clearly to limit disagreements. The accounts receivable department cannot demand that these terms be met if customers have not been informed of them in writing beforehand.

A process for handling customer satisfaction problems should keep instances of non-payment due to customer dissatisfaction to a minimum and protect the company's interests in collecting payment for goods or services rendered.

These policies should help reduce payment delays and delinquencies, but in all likelihood, such problems will occur at times. In these situations, the accounts receivable department will have to take a more aggressive approach to pursue payment, but one that is fully compliant with collections law.

Generally speaking, accounts receivable representatives may not engage in any collections practices that are deceptive or harassing. More specifically, collectors are prohibited by law from doing any of the following:

• Impersonation. A collector may not claim to be someone else, e.g. an attorney or law-enforcement official, nor may he use a false identity on letterhead or other written communication.

• Sending deceptive collection notices. Collectors may not send out notices that have been made to look like court summonses or other official documents or give the appearance of having been issued or authorized by an attorney or government agency official. Collection letters should look like other regular business correspondence.

• Knowingly collecting, attempting to collect, or threatening to collect any collection fee, attorney fee, court costs or other expenses not stated in a contract or in payment terms.

• Idly threatening to turn an account over to a collection agency or to take legal action. Collectors may only threaten this type of action if the company undertakes it in the usual course of its business and plans to follow through with the debtor in question.

• Placing harassing phone calls. Calling before 8:00 a.m. or after 9:00 p.m. or calling with excessive frequency may be considered harassment.

• Exposing the bad debt publicly. Making others aware of the delinquency is forbidden unless they have a specific interest in the situation, as would banks, other creditors, or credit reporting agencies. This means that the department may not send collection notices via postcard or in envelopes with external copy suggesting the nature of the communication. The department also may not reveal any other information about the debtor unnecessarily. If a debtor disputes a debt, the dispute must be disclosed when reporting the debt. When dealing with individuals, one may not inform or threaten to inform the debtor's employer of the bad debt or threaten to garnish his wages prior to obtaining a final court judgment.

• Intimidation or violence. Collectors may not use or threaten violence, resort to obscene or otherwise abusive language, or visit a debtor and refuse to leave upon request.

Sometimes, despite a clear and well-executed collections process, there will be the occasional debtor who still won't pay. When the opportunity costs of continuing to pursue the debt internally become prohibitive, the business is left with three options, broadly speaking: write the debt off, hire a collection attorney, or engage a collection agency. Writing off the debt appears to be the least attractive option, but if the amount is not large enough to warrant turning it over to professionals, it may be the prudent business choice. Collection agencies can be effective, but their fees are often high — amounts of up to half of an outstanding debt are not unheard of. Lawyers' collection fees are similar.

The advantage to hiring a collection attorney, rather than an agency, is that the attorney can represent the business in court, if necessary, in addition to providing collection services similar to those offered by agencies. If the business expects to file a significant number of bad-debt law suits, an attorney might be the right choice. Collection agencies don't customarily provide legal representation and concentrate instead on debt pursuit outside the court system. Depending on the business's needs and culture, this may or may not be the right alternative to hiring a lawyer.

Whether choosing an agency or an attorney (or both), it's important to find the one right for the business, who understands the nature and complexities of the business and industry and shares the company's corporate values. Since the agency or attorney represents the firm, it's important to find one whose business practices are professional and legally compliant.

An accountant, attorney or other professional advisor may be able to provide references for collection agencies or lawyers. Friends and acquaintances in other firms might also have good recommendations, as should the business's trade association. There are also local and national collection professional associations, such as the American Collectors Association, that can provide referrals.

Collections work — whether performed internally or externally — is an unpleasant business. But its inevitable unpleasantness can be limited by following a clear, effective, and legally compliant collection policy internally and engaging the services of the right external professionals when necessary.

Reprinted by permission from The Accounts Receivable Network.

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