Recent experience suggests that the economy is not quite as rosy as the politicians might have you believe. We seem to be witnessing a rise in collection cases across all sectors of the business world, including sales of goods and services, commercial landlord-tenant collections, mortgage foreclosures and borrower defaults, both commercial and consumer.
What can small businesses do to minimize credit risks and collection problems? Here are some suggestions:
- Personal Guarantees: When dealing with a corporation or similar entity, requiring a personal guaranty by the shareholders or controlling persons provides a significant level of comfort and tends to keep customers “honest” when cash flow tightens up. Small corporate customers who do not provide personal guarantees of payment are much more likely to walk away from an obligation if the business fails. Potential customers who are reluctant to offer a personal guarantee are sending a signal that they are not creditworthy.
- Security Interests: Lenders and sellers of goods on account should give serious consideration to obtaining security interests in specific property, including the goods sold, as collateral for the extension of business credit. Sellers of goods can obtain a “purchase money security interest” in the goods which allows their repossession in the event of non-payment. This requires a simple security agreement and the filing of a UCC-1 form with the Secretary of the Commonwealth. In the event of a default or a bankruptcy, repossession of unsold goods is often allowed, which helps to minimize the ultimate loss. Security interests are not practical in small transactions, but in larger transactions, or where credit is constantly being extended from month-to-month, a security interest can provide significant protection.
- Advance Deposits: Instead of selling goods or services in exchange for future payment, establish a deposit relationship with the customer, in the nature of a security deposit or advance payment, which secures future advances of credit. If a potential customer cannot do this, he or she probably cannot pay your bill in a timely fashion. Stated differently, your ability to collect may well depend upon your customer’s ability to collect from his or her customer. Thus, you are really looking at two separate credit risks.
- Monitor Your Receivables: We cannot stress this fundamental concept strongly enough. If a customer cannot pay his bill within 30 days, he has a cash flow problem. If he cannot pay his bill within 60 days, he has a serious cash flow problem, and so do you. Identify customers who do not pay in a timely fashion and cut them off, or immediately put them on a C.O.D. relationship until their past-due balance is brought current. Slow payment trends are a strong signal of impending disaster. Don’t ignore them.
Many of the collection problems we encounter are avoidable. Strong security in the form of a personal guarantee and/or security interest, coupled with diligent monitoring of payment trends, is the best insurance against loss. This is one area where an ounce of prevention can avoid pounds of trouble in the future.
— Kevin Palmer