How to Deal With Unpaid Invoices: 7 Steps Before the Account Becomes a Collection

You probably have one of those customers who were great at paying on time until they weren’t. When that customer stops paying, you need to have steps you follow to attempt to collect your money before turning the debt over to a collection agency. The key is to have an established policy and process.

• Check your records for mistakes.
• A friendly reminder.
• Follow up on a set schedule, getting firmer with each reminder.
• Make a payment plan.
• Pause work until things clear up, and enforce the contract.
• Know your deadlines and weigh your court options.
• Get a collection agency or a tax write-off.

Following up on Unpaid Invoices

You’ve sent out the invoice. You’ve waited for the money to arrive. It hasn’t, and it’s past the due date. Is there something wrong? Before you start calling the customer, double-check your own records to make sure there’s no mistake on your end. If a customer has paid on time in the past, the lack of payment could be a mistake. It might be an oversight, a miscommunication, or a logistical delay. Occasionally, a client may refuse to pay for work because they did not receive what was promised. If you find this is true, try to rectify the problem before moving to the next step. Assuming the worst about a customer can kill the relationship.

If there’s no mistake on your end, you can try reaching out to your customer directly to ask for payment. The reminder should have no hint of blame or accusation. Keep your tone pleasant and courteous, and maintain a professional demeanor. This also helps keep the customer on your side and keeps the conversation friendly. Always be polite and specific about the amount due and where to send it. Note the date of every contact you have and the outcome. These notes will show when and how you reached out to them and whether they made a promise to pay. If the situation escalates, these notes will be helpful if you need to decide to send the invoice to collections or take other action.

Establish a system for following up on unpaid invoices, and follow it consistently. Try sending the invoice once per week for two weeks. Generally, these reminders should get firmer as time goes on, but be sure to remain courteous. Each follow-up email should include a copy of the unpaid invoice. This provides them a paper trail and shows that you’ve been trying to collect. It’s important not to get angry. Anger will only antagonize the client and will hurt the chances of reconciliation.

Some customers simply don’t have the funds on hand to pay their bills. There may be a completely valid reason. If this is the case, you might consider offering your customer a payment plan. The goal is to get your invoices paid, not to punish your customer. It might not get you all of the money at once, but it can help both sides keep the relationship intact. A payment plan will allow the customer to pay back what they owe, plus any interest you might charge. It’s important to make sure you don’t get taken advantage of with payment plans. Whatever payment plan you offer, be sure to get a commitment from the client in writing, and give them the same commitment in return.

If the client still owes an outstanding amount, you may want to think about pausing your work for them until they’ve paid. Otherwise, you may find yourself adding more work to the bill they aren’t paying. Continuing to do business with customers who don’t pay on time will cost you money and hurt your business. Don’t work for free. If you do, your customer might expect that same “free” work in the future. It’s important to make it clear to the client, in writing, that you will not resume work until you receive payment. If they’ve signed a contract stating that they’ll pay your invoice, you can also enforce that. In some cases, this may jeopardize your business relationship, so be careful before you decide to do this. Whatever your decision is, make sure you follow the stipulations of the contract and do everything above board. Remember to document any decisions you make so you can refer to them later if necessary.

Legal Action

If you’re thinking about legal action, the federal Fair Debt Collection Practices Act won’t help you, because that only covers personal, family or household debts. A business-to-business invoice is not a “debt” under the Act. You have a limited amount of time to collect on unpaid invoices. Once it runs out, you can’t take legal action against your customers. The clock depends on what you’re selling. The general rule on the clock is that for the sale of goods, the seller generally has four years after the breach to sue. A contract can shorten that to one year, but never lengthen it. Other contracts in New York are on a six-year clock. In California small claims court, a business can generally sue for no more than $6,250. In Texas, it’s a little different: if you’re claiming on a contract, you can’t win attorney’s fees unless you bring your lawyer, you have to present the claim to the defendant first, and it has to stay unpaid for 30 days.

The Cost of Pursuing the Debt

When your options are exhausted, you have to decide whether you want to continue to pursue the debt by sending it to collections. It is important to consider whether the cost of pursuing the debt is worth the return. Is it time to hire a third party to help collect? Are they more than 90 days overdue? If you’re not getting answers, can’t reach them after several attempts, are getting excuses or runaround, or are seeing their payments keep failing to go through, it may be time to move to collections. The wrong time is when you are angry or frustrated with them.

Collection agencies often take about 10 to 50 percent of the payment. If the amount owed is too small to justify the percentage, however, you may simply need to write it off. If you’ve exhausted your options and know the money will never arrive, don’t spend the time chasing it. If you haven’t collected on an outstanding invoice, you may be able to write it off as a tax deduction. Under the IRS, you can only deduct a debt if you’ve already counted the amount as part of your business income. So it’s mostly only for accrual method businesses. You can only claim it in the year that the debt actually became worthless. You also have to show that you tried reasonable collection efforts. A business bad debt can be worthless for tax purposes before you go to court, as long as a judgment would be uncollectible.

You can’t always avoid overdue invoices, but you can give yourself more options if you plan ahead. Take the time to draft a contract that outlines billing expectations and how late payments will be handled. When you start a job with a new client, you might ask for a deposit on the work. This will help reduce the amount you will have to collect from them later on. Do a thorough investigation of potential clients before you work with them. Above all, maintain good bookkeeping practices and a structured policy for dealing with unpaid invoices.