In my last post I wrote about the collection process. More specific, I wrote about the end of the collection process and the use of collection letters. In that post I mentioned a strategy to settle debt just prior to writing-off the account.
Here´s the strategy I referred to.
When you get to the end of the collection process and are ready to write the account off, every plan, practice, and policy you´ve had in place to work with your customer has failed. The odds of curing the account are beyond reasonable. So, what are you´re options?
Some receivables can be turned over to collection companies, some can be pursued with litigation, and others can be sold for pennies on the dollar. None of these are desirable, but each is necessary in their respective case. An unfortunate part of business is the handling of bad debt. From an accounting perspective, bad debt is an expense that lowers net income. From a cash flow perspective, bad debt is the killer of business.
Whether you turn an account over to a collection agency, pursue litigation or sell the receivable, you´re looking at a big loss. Administration fees, handling fees, legal fees, discounts, and negotiated reductions eat into your portion of the collected amount. If you get 40% of the face value of the receivable you´re doing well.
So, just before you write off the account and give the problem to someone else, make one last call to your customer. Without emotion, offer them the ability to settle the account for an amount over your NET cost of write-off. For this strategy to work, you need to know your cost of collection or litigation and subtract it from the amount you can reasonably expect to collect. For example, if you have a $1000 receivable with a cost of formal collection estimated at $500, you can make a last offer to your customer to settle their account for $600.
For many customers this is a welcomed call — they get to avoid further collection, possible litigation, and further damage to their credit. You win because you get some money – more than you would were you to transfer or sell the receivable – and you get your money faster than the next phase of collection.
When receivables get this far along there aren´t many bright spots. A reality to bear in mind is your business needs money to survive and grow. And some money is better than no money. While you don´t want to make settlement of debts a norm, the reality is there are scenarios whereby settling is a smart business decision.
Remember, with few and rare exceptions, you´re business relationship with a customer in this stage is over. Emotions aside, you need to end the relationship as quickly and profitably as possible. Settling the debt may be the quickest and most profitable way to end.
What do you think? From the perspective of a creditor, what do you think of settlement offers? Do you think they´re a legitimate option for business owners handling bad debt? Why or why not?