In the last part of this series, we covered the consumer side of bad debt charge-offs and how the IRS handles that from a tax perspective. Today I want to delve into the business side of bad debt charge-offs. This side of things is usually quite complex and hard to generalize but I will attempt to keep my “tax guru” side in check and you on board.

Business Not What It Used To Be?

Let’s assume that we’re talking about a business (Corporation or LLC that is treated as an S-Corp for tax purposes) that has been hit hard by the recession and has run out of money to pay its creditors. Typically in cases like this the business will notify creditors who will then turn around and liquidate the business assets in order to attempt to recoup at least part of the debt owed. Once that happens the business is faced with a balance plus late fees and interest to cover.

Many times business owners will be able to negotiate a settlement far under the remaining balance owed and once that agreed upon price has been paid, the business owner will generally feel they have taken care of everything and their ordeal is over. Hooray!

But Wait! There’s More!

It’s not exactly time to celebrate yet. Come tax season the, now former, business owner receives a 1099-C for the canceled debt and interest. Now what to do? At this point the business owner would be wise to contact their accounting professional who will review the situation and offer advice on how much of that total will actually be taxable.

Their accounting professional will be able to determine this number by assessing the net worth of the business (a negative number at this point), the fair market value of any remaining business assets, and the amount of the canceled debt among other factors. Whatever the balance is, if any, is the amount of taxable income the business owner would be liable for paying taxes on.

The business owner may also be entitled to an ordinary business loss equal to the difference between the fair market value of business assets that were auctioned off (or the canceled debt, if less) and the cost of the assets to the owner.

Call Now And Save

As always there are a hundred different variables that will affect the outcome of a scenario like this; this example is a highly simplified version used to provide a general understanding of the concept and should not be taken as de facto for all situations.

My goal is to provide fair warning to business owners with a loss that they WILL have to deal with charged off debts when it comes time to handle their taxes. I also want to point out that it isn’t nearly as awful as it might first seem and, with the help of a professional, your tax liability may be significantly reduced or even eliminated. So don’t ignore those 1099-Cs, if you do it will create an even bigger and more expensive mess to straighten out.

Very few business owners start their company with the goal of becoming collection agents, so being put in that position can lead to avoidance. You have a personal relationship with your clients and it can become an emotional issue for many small business owners—who wants to add stress to people you know are already struggling? So let’s take the emotional baggage out of the equation by setting up some simple guidelines that communicate your expectations and provide more up to date information for your clients that will help them better budget their payments so you get to avoid being “the bad guy”.

No doubt about it, invoicing is tedious. But with a little tweaking, the process can be improved to make communication between you and your clients/customers more frequent and reduce accounts receivable aging.

Avoidance and lack of communication leads to misinformed or uninformed (and eventually very frustrated) clients, this is often the first mistake that starts you on the road to the A/R blues. Unappealing as it may seem, staying on top of your invoicing improves your cash flow, helps you identify problem clients more quickly, reduces invoice disputes since clients still have the transactions fresh in their heads, and improves client relations because it helps your customers manage their own cash flow.

Your new mantra: Invoice clients/customers promptly and more often!

So where do we begin? As with most things, having the right tools for the job can save you time, frustration and money. The invoicing process can be drastically simplified with commonly used accounting software packages like QuickBooks which will automate the invoicing process, producing professional looking invoices that can be mailed or e-mailed to your clients. The power behind most invoicing systems is that you can enter time, products and reimbursable expenses into the program’s customer center during work hours and invoice on a daily basis if needed. Yes, these systems can take some time to set up and often the use of a consultant to guide you through the installation process, however, the upfront investment of time and money significantly reduces the time and embarrassing mistakes that can ultimately show up on your invoices down the road.

How often you invoice is up to you, but ideally you’ll want to shoot for invoicing on a weekly basis or a biweekly basis. Invoicing on a daily basis any finished work is a great way to stay on top of your invoicing workload too. This invoicing schedule might seem somewhat overkill, and you may be worried about your client’s reaction to the change but think of it more like a marketing campaign than billing. “The squeaky wheel gets the grease” and the more often you correspond with the customers, the more likely your invoice will fall at the top of their list for prompt payment.

Okay, so you’ve got the “why” and you’re ready to get your accounting software setup, now let’s outline the steps to implement your plan of action:

1. Invoice your client and include that the amount was either deducted from their prepaid account or that the invoiced amount will be deducted from their payment account on file (Credit Card, ACH) within 3 business days of the invoice date. Always, always include an invitation to call you if they have any questions.
2. Prepaid accounts need to be notified of their balance and any additional payments needed to keep their account current in order for work to continue. If this prepaid account runs out, then work stops until additional prepayment funds are received.
3. The accounts are then paid within the 3 business days of the invoice date and either accepted or denied by the credit card merchant or bank.
4. Any denied accounts are promptly followed up on and any work on that account is stopped until the invoice payment is satisfied.
5. Clients who do not follow up on denied accounts are placed into the collection process (this will come later in our series).

This process is service-based but can be easily modified for retail business: Payment must be received in full prior to delivery. Better yet, never order product for the customer until the client has at least paid your costs on that product by requiring a non-refundable deposit.

Don’t allow yourself to be at the mercy of your clients; take your power back by implementing these simple and extremely effective processes! It’s not rocket science, but there are still companies that will not subscribe to these simple rules who will find themselves singin’ the A/R Blues and, sooner or later, out of business.

Be proactive with your client communication and be honest about your expectations; you’ll have happier clients, enjoy your business more and have the satisfaction of seeing it thrive.

_{Fred Daus is the Chief Executive Officer and founder of Fredrick James Accounting, Tax & Consulting. He is a member of National Society of Accountants and the National Society of Tax Professionals and has been helping clients save money and grow their income since 2001. Fredrick James is an innovative, full service accounting firm in Clearwater, Florida with a focus on providing outstanding service, tax savings and financial growth to clients in the Tampa Bay area,  Nationwide and around the world. Visit our website www.FredrickJames.com or call 727-230-0716 for more information.}

With the economy in disarray, many businesses are faced with this scenario that not only causes cash flow to slow to an alarming trickle; it actually adds the additional cost of trying to collect from slow or non-paying clients. Most business owners don’t realize this is actually an added expense but once you take into account the time invested in trying to collect on services/products rendered that could be used to generate new revenue, the added systems needed to check clients’ credit worthiness, the time needed to monitor payment collections, send delinquent account collection notices and, in extreme circumstances, make phone calls and visit non-paying clients, it is easy to see how quickly the additional expense adds up.

Now you find yourself singing the Accounts Receivable Blues, “Everyone wants what I’ve got to offer, but no one wants to pay until I beg for it.” You don’t have to get stuck singing that song though; there IS a way to avoid getting the AR Blues if you just change your tune to “Pay me at the time of purchase or secure your account.”

Over the next few weeks we will explore several ways to stop the Accounts Receivable Blues, starting with one of the most effective changes a business owner will make to start putting cash back into the bank—having a stated A/R policy.

Avoiding the A/R Blues, Part I

The first change business owners may want to explore is implementing an A/R policy. Over the next year or two, it is expected a lot of companies will go out of business due to cash-flow problems from slow A/R payment or nonpayment. Our goal is to help you NOT become one of those statistics.

Your clients aren’t avoiding paying you out of spite or because they want to. The reason that many business clients are not paying their invoices on time has to do with the banks slashing and/or cancelling their credit lines. The loss of sufficient credit forces many businesses into a cash-flow crunch and the inability to make payments in a timely manner.

Unfortunately, yes, we are all in this together and one business’s cash-flow problem can quickly turn into another company’s problem. If a business can’t pay a vendor, then the vendor can’t pay its bills either. In other words, if not treated, a simple A/R flu can quickly turn into a pandemic that will ravage the entire economy.

So how do you avoid getting caught up in another business owner’s cash crisis? You need to tighten your credit policies just like the banks and stop issuing unsecured credit to your clients who have not proved credit worthiness. This will limit your exposure to slow or non-paying customers.

Two possible options to help move you in this direction would be; no more unsecured credit accounts and the establishment of prepaid accounts. You may also want to require that your client’s account must be secured with a credit card, bank ACH agreement or cash.

One of the most common questions I get when suggesting this course of action is, “What if my client leaves because I changed the policy?” That may happen, but in my experience, it is usually the problematic client who will leave as a result of your new A/R policy—the same client who was costing you money, slowing your cash flow and jeopardizing your business in the first place. Your good paying clients generally won’t have any issue with your new policies, especially if you take the time to explain your reasons for taking action. After all, you help their business succeed so they don’t want to see you go under either!

Collecting on accounts that are delinquent is a waste of company time and is very costly. For a majority of my clients collections means that the CEO or President has to make collection phone calls, oversee collection letters, visit clients for collections and file collection claims against slow or non paying clients. Not only does the company lose part of this income as uncollectable, but the company loses its most valuable asset, its leader’s time that could have been used to create more income for the company.

So be proactive now to stop the pandemic of nonpaying clients, avoid the A/R Blues and, instead, invest you’re valuable time into building your business & producing revenue. Then take a moment to rest, regroup and enjoy the fact that your business will prevail!

Fred Daus is the Chief Executive Officer and founder of Fredrick James Accounting, Tax & Consulting. He is a member of National Society of Accountants and the National Society of Tax Professionals and has been helping clients save money and grow their income since 2001. Fredrick James is an innovative, full service accounting firm in Clearwater, Florida with a focus on providing outstanding service, tax savings and financial growth to clients in the Tampa Bay area,  Nationwide and around the world. Visit our website www.FredrickJames.com or call 727-230-0716 for more information.