What is a Collection Agency?

A collection agency is a business that contacts customers on behalf of their suppliers, using various methods to enforce payment of overdue receivable and loan payments. Clients typically refer unpaid invoices to a collection agency once the invoices have exceeded a certain number of days unpaid (such as 90 days), or when the collections manager decides that no further in-house collection activities are worth pursuing.

Why Use a Collection Agency?

Clients typically turn to collection agencies when they are unable to collect funds through their own internal efforts, which are constrained by the need to “play nice” with customers in order to maintain long-term relations with them. Collection agencies tend to be more aggressive and persistent in their activities, and so are more likely to be targeted at those customers with whom a client no longer wants to maintain an ongoing relationship.

Collection Agency Fees

There are many fee arrangements between clients and collection agencies, with the most common being a commission paid only when funds are successfully collected from customers. In this case, the collection agency collects from customers, extracts its commission, and forwards the remaining amounts to its clients. This approach maximizes the incentive for the collection agency to pursue customers aggressively. An alternative approach is a standard monthly fee that buys the client a certain amount of collection agency staff time, but which tends to have a lower success rate.

Advantages of Using a Collection Agency

There are several distinct benefits associated with shifting some collections work to a collection agency. The key advantages are as follows:

Improved recovery rates. Collection agencies specialize in debt recovery and have trained staff who know how to deal with delinquent accounts effectively. Their expertise and persistent follow-up often result in a higher percentage of recovered funds compared to internal efforts. By outsourcing collections, businesses can maximize the chances of recovering overdue payments without dedicating additional internal resources.
Focus on core activities. Using a collection agency allows a company to redirect its time and energy back to core business operations. Instead of chasing down unpaid debts, employees can focus on sales, customer service, and growth initiatives. This improves overall efficiency and ensures that administrative tasks like collections don't drain valuable internal resources.
Legal expertise. Collection agencies are knowledgeable about debt collection laws and regulations, helping businesses stay compliant and avoid legal pitfalls. They understand how to handle disputes, issue formal notices, and escalate cases without violating debtor rights. This legal expertise reduces the risk of costly lawsuits or regulatory fines stemming from improper collection practices.

Disadvantages of Using a Collection Agency

There are a number of problems associated with using a collection agency, which are as follows:

Cost. A major concern is the fee charged by collection agencies. This can comprise a large proportion of the amount collected, so that your net collection may be rather low.
Customer relationship damage. Collection agencies can be quite aggressive in their collection activities, which can drive away customers. Of course, this is less of a concern when the customers in question have an established pattern of not paying; you probably do not want to grant them additional credit anyways.
Minimal control. Once you hand over an invoice to a collection agency, you will have no control over how the agency chooses to conduct its collection activities. This can result in quite aggressive collection tactics.
Time delay. You may find that it still takes an extended period of time to generate any cash from invoices turned over to a collection agency. This is because the agency will prioritize its collection work based on the size and collection difficulty associated with each invoice.

Alternatives to a Collection Agency

As an alternative to using a collection agency, a business might set up an internal collection agency that operates in the same manner. Or, it may work with a law firm to send out legal letters on the law firm’s letterhead, demanding payment. Both approaches are more robust than simply using an in-house collections team, and give the business some separation from these more aggressive collection approaches.