Handling Customer Credit – Dealing with Collections
Sometimes customers just do not pay their bills. Your business, however, has a legal right to collect any money that they owe you. That doesn’t mean you show up on their doorstep the very day an invoice becomes past due. It does mean, though, that you have to enforce your credit policies in a way that gets cash in your door without making your customers run away.
After a while, you’ll get the hang of how your customers work. Some will pay right away; others will send a check after a reminder phone call or two. Others will say they’re sending checks, then won’t do it. The fine line you have to walk is whether to continue extending credit to delinquent customers or to cut them off and risk alienating them.
The Aging Schedule
In a perfect world, every customer would pay every invoice right on time and no checks would ever bounce. There are customers like that, plenty of them, but certainly not all fit into that mold.
Fortunately, there is a single accounting report that can help you stay on top of your delinquent accounts, figure out which ones are still collectible, and show you which are lost causes. That report is called the aging schedule, and it will give you all the information you need to manage your accounts receivable more efficiently, which in turn will improve your cash flow. An aging schedule includes all of your credit customers.
It classifies each of their invoices in one of four time categories:
- Current
- Over thirty days
- Over sixty days
- Over ninety days
Aging schedules count from the invoice date, and compare it to the cur- rent date, which means that an invoice in the over-thirty category would be for a sale that took place at least thirty-one days ago, not for an invoice that was already more than thirty days late. In most cases, you don’t have to worry about invoices until they hit the over-sixty-day mark; that does indicate the invoice is more than a month past due (if you offer thirty-day credit terms).
Once an invoice hits the over-sixty column, send out a past-due notice; that often works to get the invoice paid. Invoices that are still outstanding after ninety days require a phone call from someone at your company. If the customer is not responsive, you may need to call in a collection agency.
What to Do about Bad Debts
Sometimes, no matter what you do, you just won’t be able to collect from a customer. When that happens, all you can do (from an accounting standpoint) is write it off. As soon as you know for certain that a particular account is uncollectible, remove that account from the books and consider the bad debt a cost of doing business.
The accounting procedure differs depending on whether you use the cash or accrual method. Technically, there’s no such thing as bad debt expense under the cash basis, because no sale is recorded until cash changes hands. If you haven’t booked a sale, you can’t book a corresponding loss. There is one exception: a bounced check. When a customer pays you with a check, you record that sale. If the check is no good, you can deduct the full amount as a bad debt.
With accrual accounting, you write a journal entry to recognize the bad debt. Since these are (hopefully) rare entries, they are recorded in the general journal. You do this with a debit to bad debt expense and a credit to accounts receivable. Remember to credit both the accounts receivable control account in the general ledger and the individual customer account in the subledger.