Cash Flow

Five Ways to Reduce Bad Debt

It may be your most aggravating category of cost. You probably won't be able to eliminate bad debt, but keeping it under reasonable control is with...
Myles WatlingOctober 1, 2013

Myles Watling, CFO, The Phelps Group

Myles Watling, CFO, The Phelps Group

Many companies set aside hefty reserves, often as much as 10 percent of revenue, to mitigate against future bad debt. Some well-managed companies get away with about half that. We’re a Los Angeles-based integrated marketing communications company – with both advertising-agency and public-relations functions – and, after about 30 years and $100 million in revenues, we’ve experienced only $250,000 in bad debt, or about a quarter of 1 percent.

How did we do it, especially in a wild and crazy business like advertising and public relations? Following are five tips for reining in bad debt that we’d like to share with other companies.

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Discount the Future, not the Past
When there’s a dispute over costs, and a discount is warranted and necessary, we offer a slight discount on future work, not on the completed project. While we try to accurately estimate the cost of a job, which in our business often comes down to time spent on it, there are often changes in the course of the work (to a website, for example) that result in overages. Even though we strive to accurately predict such changes, the creative process is what it is. But rather than reduce the cost of our actual, legitimate hours spent, we assume partial responsibility for the overage and proffer a discount on future work. That provides substantial good will to the relationship – and ensures another project.

Call Them on Late Pay
Regardless of the reason – and there’s always a reason – don’t let a client assume that late payments are OK with you. It’s a slippery slope that inevitably gets worse. It’s not just a matter of respect; it’s a reciprocal arrangement. How would they react if your product was late? Wouldn’t they mention it? Then why should their “product” – their payment – be even a day late?

We usually allow the first payment to be a bit late, as payment systems and procedures often need to be established. But allow your company’s self-esteem to shine through, and mention it. If the first two payments are late, it’s very much a red flag, and you’ll need to broach the subject of late-payment penalties. Often just the mention of those will improve behavior.

Also, in our advertising media buying practice, there’s a long-established policy of “sequential liability”: if we buy media for a client’s ad campaign, the medium is paid only after we receive payment from the advertiser client. If a client is late in paying us, the medium will bug us – but it’s not our fault. The medium will often alert us that it will contact the client directly for payment, which is as it should be. The client is thus bugged by two annoyed parties, which can be unpleasant. This can apply to any sequential supplier relationship.

Surround Them with Concern
Joe Phelps, our founder and CEO, wrote an organizational business book that was published in 2002 called Pyramids Are Tombs. It’s now a classic text, used in university marketing departments, that outlines the potential failure of vertically organized companies and argues for flat, self-directed, client-centered teams that connect with clients on multiple levels.

What Joe didn’t mention at the time is that our type of organizational structure, which provides multiple points of client contact, is hugely effective in immediately communicating in ways that can head off financial problems. For example, marketing people can express concern over an invoice being “approved,” while financial people can focus on it being “paid,” and there’s less wiggle room for the client based in its own internal processes.

Be an Aggressively Open Book
Our policy of transparency – with timesheets, subcontractor and supplier invoices, out-of-pocket expenses, etc. – is more than just a policy. It’s code for “there should be no delays based on questions.” While our clients know our rates are competitive and reasonable, they are free to audit us at any time and, if they do, will often discover that we over-service them and don’t even bill for what we could.

We follow industry standards on audits, though, and do not include such items as salary costs and detailed overhead.  We also don’t partake in “discover” audits, where auditors are reimbursed according to what they find, as that represents a conflict of interest.

Prequalify. Prequalify. Prequalify.
Of course, the ultimate means of reducing bad debt is to be selective about the clients you work with. But why are some companies more successful at that than others? Experience counts. We’ve been around over 30 years and with one phone call can ascertain the credibility of a prospective client through our extensive network of contacts. And that’s the point: Don’t hesitate to pick up the phone and make a few calls to others in your industry. Do you think the prospective client hasn’t done the same regarding you?

In the fickle agency business, it’s rare for an agency to resign a client. It’s usually the case that a client fires an agency (for a variety of fickle reasons). We usually call the previous agency for a quick assessment. If late payment was a factor, the previous agency won’t be shy in sharing that. And if complaining about late payment was a factor in the termination of the relationship, who needs that? Finally, we tend to be frugal when it comes to startups and spinoff companies, sometimes choosing to have the parent company, if there is one, co-sign as guarantor.

There are other operational behaviors that can help reduce charge-offs and bad debt, but the ones listed here seem to be the most effective. If you know you did good work, insist on getting paid.

Myles Watling, CFO of Phelps, can be reached at [email protected].