Collection Controls (#171)
/In this podcast episode, we discuss the controls that can be applied to the collections function. Key points made are noted below.
The Need for Collection Controls
The main issue with collections is that receivables can become stale really fast, so you need to stay on top of them. To do this, you need three controls. The first one is a clear dividing line that defines when a receivable is considered to be overdue. As soon as a receivable hits this date, you must take action to collect the receivable. In a lot of organizations, there’s a tendency to not take action for too long, so customers get a free ride for a couple of weeks past when they were supposed to pay.
Types of Collection Controls
Sometimes the delay is due to indifference about collections, but sometimes the excuse is that the collections staff starts making calls early, and is told that the check was just put in the mail. So this means the collection staff just wasted its time contacting customers. But is that really the case? What the collection staff actually did was post a notice with customers that the company follows up on all receivables that are even slightly overdue, which sets the tone for the next customer payment. And for that reason, I advocate setting that dividing line just a couple of days after the receivable due date.
The second control is to make sure that every overdue receivable is assigned to someone. This is the responsibility of the collections manager. So as soon as a receivable hits that dividing line that triggers collection activity, it has to be formally assigned to someone. Otherwise, it’s just going to hang there, and nothing will happen.
A common method for assigning customers to the collections staff is to always assign the same customers to the same collections staff. By doing so, collectors gain some familiarity with customers, and can build up relations with them over time. To an extent, this makes collections work more efficient. But on the downside, collectors may start to sympathize with customers, and allow them some payment delays. If this appears to be happening, rotate customers among different collections staff.
And the third control is to make sure that continual pressure is placed on the customer to pay. From a management perspective, that means placing continual pressure on the assigned collections person to engage in collection activities. Sounds simple, but it requires active management.
You cannot let any receivable sit quietly for any period of time. Instead, there needs to be a barrage of collections work going on.
You can only achieve this level of active management of the collection staff if there’s a good record keeping system in place. Ideally, the collections people record what they did with each overdue receivable in a central database, so the collections manager can skim through it and see if anyone requires a little push.
It’s possible that you could impose a standard progression of collection activities on the collection staff, such as always starting with a dunning letter and then going to a phone call. I don’t like that approach, though. The reason is that an experienced collections person knows which buttons to push with each customer, and so should be allowed to do so. They can take any steps they think are necessary to collect a payment. If you still want to impose a standard progression of collection activities, at least confine it to the least experienced collections staff.
In short, the basic theme for collection controls is to take action early, and don’t let up.
Now, there’re some other controls involving collections. The main one is credit memos. We issue a credit memo to offset an invoice that’s not going to be paid, or at least not paid in full. The credit memo is created in the accounting system and then offset against an overdue invoice, which cancels out the invoice. The trouble is that credit memos can be an easy way out for the collection staff, and could be a source of fraud.
For example, a collections person is having a hard time collecting from an annoying customer, and just wants to get rid of the blasted receivable. So he creates a credit memo, and – poof – no more collection problem, because the invoice just went away.
The other issue is fraud. If a collection person also receives cash payments from customers, this person could pocket the payment and create a credit memo to offset the related invoice.
These issues bring up two possible controls. One is to keep the collection staff well away from any customer payments.
Your best bet here is to use a lockbox system, where payments are sent to the company’s bank, and never even enter the accounting area. The other control is to lock down access to the credit memo creation module in the accounting software, and require manager approval before a credit memo can be created.
However, there is a limit to having the credit manager approve every single credit memo, since a lot of credit memos are for really small amounts, usually because a customer short paid a very small amount on an invoice. If this is a problem, allow the credit staff to create small credit memos without any further approval from a manager.
Another control that makes sense is to have a feedback loop to the credit department. The collections staff is on the back end of the credit granting process, and so it has to collect credit that someone else granted. If the collections staff can’t collect on a receivable, the credit manager needs to know about this right away, so that any further credit is shut down. A possible extension of the concept is to give the collections manager the override authority to shut down credit for a customer, no matter what the credit manager may say. That’s a bit extreme, but may be worth considering.