When you start a business, you must decide

Starting and Running a Small Business:

Extending Credit & Getting Paid

In this chapter, you’ll find out how to establish credit practices that help ensure that you get paid when you should. You’ll also learn how to comply with federal and state credit laws and what to do if customers, clients or patients don’t pay when they’re supposed to.

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A. The Practical Side of Extending Credit

Some businesses give customers 30 or 60 days to pay for goods and services. They may even let customers make installment payments over a longer period. For example, a small wholesaler of children’s music products might require retail customers to pay at the time of sale, but extend 30 days’ credit to wholesale customers. Similarly, many professionals and other service providers extend short-term credit to clients and customers, who are expected to pay after receiving a monthly invoice.

If you extend credit, you need to set up a well-organized, accurate, easy-to-use system of accounts, send out bills periodically and keep after those who pay slowly or not at all—all of which takes time, money and effort. Many small business people fantasize about avoiding the whole mess by requiring customers to pay cash. Unfortunately, this sort of day-dreaming is normally just that; in many businesses and professional practices it’s almost impossible to operate if you don’t extend credit.

1. Professional and Personal Service Businesses

In many professional or consulting practices, it used to be considered unusual to require a client or patient to complete a formal credit application. No longer. Today, credit applications are becoming routine, because businesses simply can’t afford to work for deadbeats. But if you shy away from a formal application, you can still gather much pertinent information from your new client or patient intake sheet. Ask where the person works and banks. Ask for the name of the “nearest relative not living with you”—useful information if the client or patient skips out.

Health care professionals will, of course, want to inquire about insurance or Medicaid/Medicare coverage. Consider offering a modest discount (say, 5%) for payment at the time services are rendered—it usually leads to prompt payment. And think about posting a dignified sign saying: “If it’s convenient, payment is appreciated when the bill is presented.” If you accept credit cards, there’s really no reason for the patient not to pay on the spot.

Lawyers, accountants, appraisers, engineers, dentists and other professionals may appropriately ask for advance payment to be applied against the first batch of services, especially if a new client or patient needs extensive services. One way to do this is to present a fee letter to each new client. The letter might state that new clients are asked to pay a retainer and that future payments are due ten days from billing.

Another positive thing a professional or consultant can do is to routinely record bank account data about the client or patient as payment is received. Then, if you have to sue the client or patient, you have one more place to turn to try to satisfy your judgment.

If you’re worried that someone isn’t creditworthy—particularly if the bill is likely to mount rapidly—you can run a quick credit check with a credit reporting agency. Credit checks are so routine these days that this won’t drive away business. However, you should notify the client or patient beforehand. Also, before using credit reports, familiarize yourself with the Fair Credit Reporting Act and similar state laws. For example, if you reject credit for a client or patient based on a credit report, you need to disclose this to the person, as well as the name, address and phone number of the credit reporting agency that gave you the negative information.

Putting Professional Relationships
on a Sound Financial Footing

If you have a professional practice or run a consulting or personal service business, consider giving each client or patient a written statement of your billing procedures, so that they know what to expect.

It is also businesslike and inoffensive to prepare a letter of retention spelling out the services you’ll be performing, how much you’ll be charging, when you’ll be billing and when payment is due. Such letters may even be legally required. In California, for example, lawyers and clients must sign a fee agreement if the expected fee is more than $1,000 or the fee is contingent on the outcome of a lawsuit.

You could even take the retention letter one step further by providing payment envelopes for the patients to use in sending their monthly checks. This approach works for professionals where fairly predictable services are delivered over a defined time period.

Your letter should state when you expect to be paid—usually within ten days of the statement date. Also, list the amount of any interest or finance charges you’ll assess (as permitted by state law) if payment is late, and reserve your right to stop rendering services. (In a few professions, rules of professional ethics may affect how and when you can terminate the relationship.) Have the client or patient acknowledge in writing that he or she has received your letter and agrees to its terms.

To find out legal limits on interest or finance charges, check the index to the annotated statutes (sometimes called a “code”) for your state—available in any good law library. Look under the terms “interest,” “usury” or “finance charges.” Also, your professional or trade organization should have helpful information.

2. Wholesale and Manufacturing Businesses

If you’re a shoe wholesaler, software company or clothing manufacturer—or if you’re in any other wholesale or service business—you should have a credit policy, and you should insist that customers complete a formal application for credit. The details of your credit policy will depend on the kind of business you’re in and the type of customers you serve. Here are some issues to think about:

• How many days after billing is payment due?

• Is there a discount for early payment?

• Do you require pre-payment or COD terms for certain classes of customers?

• Do you add interest or finance charges? If so, how much?

• When are credit checks required? (For example, you obviously wouldn’t require a credit check if the customer is the government, and probably wouldn’t for a major, well-established company. On the other hand, you likely would want to check on the credit of a new small business or an individual making a large purchase.)

• How are credit limits determined?

• When and how often do you send past due notices and follow up with phone calls?

• Do you keep selling to a customer whose account is overdue?

• At what point will you begin aggressive credit efforts?

When you approve credit for new trade accounts, let them know the maximum credit you’re allowing and when they’re expected to pay—as well as other relevant features of your credit policy.

Should You Charge Interest?

Most businesses don’t charge interest or impose finance charges in exchange for granting credit. More typically, interest is charged when bills aren’t paid within the agreed time, often between ten and 30 days. If you decide to impose these charges, you must inform the customer how the charges will be computed. The Truth in Lending Act, which applies primarily to sales to consumers, prescribes the disclosures you must make—but not the rates you can charge. That’s done by state law.

One reason to consider adding interest or finance charges after a certain date is that customers who are short of cash tend to pay first the bills that carry such charges. Other incentives for early payment include:

• Discounts for prompt payment—for example, 5% off if the customer pays his or her bill on the spot or within ten days.

• Free shipping and handling (a big item these days) for customers who pre-pay.

• Making the customer responsible for paying for court costs and reasonable attorney fees required to enforce collection if the customer doesn’t pay as agreed. The customer must agree to this, either in a credit application or a separate contract.

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B. Collection Options

Suppose you can’t get the customer to pay up voluntarily. What next? If you’re not willing to write off the debt (which is sometimes the wisest thing to do), you have three collection options:

• sue in small claims court

• hire a lawyer

• turn the account over to a collection agency.

Each choice has pros and cons. Small claims court is inexpensive and speedy. The downside is that it can take a good chunk of your time. Furthermore, any judgment that you receive may be worthless if the debtor lacks a job or bank account.

Lawyers can be effective, but they’re expensive. Consider using a lawyer to write dunning letters. Many lawyers are willing to do this for a nominal charge.

Collection agencies are good at tracing elusive debtors, but they take a big percentage of what they collect for you.

Excerpted from the “Legal Guide for Starting and Running a Small Business”, by Fred S. Steingold