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What to Do When You Don’t Get Paid

March 24, 2010

by Barbara Weltman  at the Business.gov Community

In today’s tough economy, there is an unfortunate domino effect in accounts receivable—your customer is late in receiving payment so it becomes a late payer of your invoice; unless you receive payment you could be short of cash needed to pay your bills. If your business routinely bills for goods and services and you’re sitting with accounts receivable that have begun to age, be aware of the practical and legal steps you can take to collect what you’re owed. 

Take action quickly
The longer you wait to begin collection actions, the less likely it becomes that you’ll receive what you’re owed. It has been reported that when receivables are 90 days past due, about 27% will never be collected. At six months, 44% will remain delinquent, and after a year, it’s likely that 75% of your receivables will never be paid. The lesson: Take action as soon as your accounts receivable are past due, as you define this (e.g., 10 days, 30 days):

  • Email the customer to verify receipt of the invoice.
  • Follow up with a personal call to the customer inquiring whether there are any special circumstances causing a payment delay. If yes, you may want to work out terms with the customer—giving more time to pay, accepting partial payment immediately with the balance delayed, or some other payment schedule.
  • Stop further business with the customer until the payment issue is resolved.

Taking collections to the next level
If you’ve done what you can in house, consider more extensive action. There are three options:
1) An attorney can send customers a collection letter reminding them of their obligation to pay and promising to pursue legal action if they fail to pay.
2) A collection agency can seek to recover what you’re owed. Typically, they receive a percentage—usually 25% or more—of what they collect. Only use a reputable agency, which you can find through the *Commercial Collection Agency Association.
3) You can go to small claims court. Each state has its own rules and procedures for these legal cases, such as a dollar limit on the amount you can sue for. Find a link to small claims court in your state *here. Usually, you don’t need a lawyer to represent you, the cost of the process is minimal, and the time for action is rather quick. Check with the clerk of the court in your state. Caution: Even if you are a victor in court, there’s no guarantee you’ll recover any money. You’ll still need to find the customer’s assets so collection can proceed.

Taking action if your customer files for bankruptcy
Consumer and business bankruptcies soared in 2009, increasing 32%, as reported by *Bankruptcy Statistics. If you suspect your customer is on shaky financial grounds and could go bankrupt, try to obtain payment upfront before shipping any additional goods or doing any more work.

 If your customer goes belly up and seeks bankruptcy relief, what can you expect? You’ll have to cease collection efforts immediately. You may be able to:
• Recover goods you’ve already shipped if they haven’t been paid for.
• Band together with other unsecured creditors to negotiate terms of repayment if a business customer files for reorganization.
• File as an unsecured creditor if the business customer files for liquidation. Here you may get no more than pennies on the dollar.

Work with a knowledgeable attorney to determine your rights and the best course of action under the circumstances. If the amount owed is small, it may not make financial sense to incur the time and cost of pressing your claim.

Writing off uncollected amounts
Whether you can take a tax deduction for the amount that you don’t collect depends on your method of accounting. If you are on the accrual basis, you can write-off uncollected receivables when you determine they are partially or fully uncollectible. Businesses can use the specific charge-off method to deduct these bad debts. The amount you deduct should be “charged-off” (removed) from your books. If, unexpectedly, the customer pays you after you’ve taken the write-off under either method, you’ll have to report the payment as income.

There is an alternative method for handling bad debt write-offs related to services you perform, called the “nonaccrual experience method.” Under this method you don’t accrue service-related income if you don’t expect to be paid for services performed. 

It may seem incredibly unfair but if you use the cash method of accounting, you cannot take a tax deduction for uncollected payables. You effectively lose the time and effort you put into the job. For example, say a dentist did extensive bridge work for a patient who refuses to pay him and going after this person in small claims court would prove futile. The $3,000 for labor performed is lost (the dentist can deduct any cost for the bridge that he paid the laboratory). 

Preemptive moves
Before the horse is out of the barn and you’re left with uncollected receivables, revise your billing policy. Stop worrying about collecting receivables by getting customers to pay at the point of service. Enable them to pay for goods and services via credit card, debit card, or electronic payment methods. 

*Links to a non-government Websites 

Additional Resources: Getting your Customers to Pay-Up: Part 1 – Tips for Protecting Yourself from Non-Paying Customers; Getting your Customers to Pay-Up: Part 2 – Tips for Collecting from Non-Paying Clients 

Barbara Weltman, tax and business attorney, author, speaker, radio show host, publisher of monthly e-newsletter, “Big Ideas for Small Business(R)” and daily emails, “Idea of the Day(R)”, and an advocate for small business; visit www.BarbaraWeltman.com to find more articles and constructive help for small businesses and entrepreneurs.

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