How to Deal with Slow Paying Clients
It's no secret that cash flow is a key indicator of your agency's health. Slow paying clients put stress on your business by reducing the funds available for payroll, overhead, and new business development. Oftentimes, the slowest bill payers are your biggest clients, which may make you less willing to impose penalties for late payments. A critical KPI to monitor cash flow is Days Sales Outstanding (DSO). DSO is simply a measure of how quickly clients pay their bills.
How to Calculate Days Sales Outstanding
Days Sales Outstanding is commonly referred to as collection efficiency, average collection period, receivable days or aged receivables. All these terms measure the same thing ─ how efficiently you collect money owed to your business. The faster receivables are collected, the better your agency's cash position. For simplicity throughout this article, we'll stick with the term Days Sales Outstanding.
The formula:
First, calculate your daily revenue: Total revenue (for last 12 months) divided by 365 (days in a year)
Second, find your Days Sales Outstanding: Accounts Receivable (dollar amount of unpaid invoices for the last 12 months) divided by Daily Revenue
An Example:
Total revenue: $3M
Daily revenue: $8,219
Accounts receivable: $500K
Daily Revenue: $3,000,000 ÷ 365 = $8,219
Days Sales Outstanding: $500,000 ÷ 8,219 = 61
In this example, the Days Sales Outstanding is 61 days. In other words, it is taking this agency about two months to collect payment from its clients. It can be challenging for a business to float a client for multiple months and still keep 2 - 3 months of cash on hand for emergencies. So, unless you want to tap into lines of credit, you should aim to collect invoice payments within 45 days of the invoice date.
Feel free to plug in your own numbers to measure your Days Sales Outstanding.
3 Tips to Deal with Slow Paying Clients
1. Timely Billing
The longer it takes for a customer to receive an invoice, the longer it will take for you to receive payment. Of course, sending an invoice quickly doesn't guarantee faster payments, but you can guarantee that sending an invoice late will result in a late payment.
To facilitate timely billing, you should have clear milestones in your billing process dictating when to send invoices (after a verbal agreement, when the contract is signed, after partial delivery of services, or after the contract is fulfilled). Regardless of which milestone triggers an invoice, your client should receive invoices on a consistent and predictable schedule.
2. Reward Early Payments
Have you ever had a client hit you with the "See, what had happened was…" when you followed-up on an invoice? Although they might be experiencing a cash crunch, and you want to be supportive, it still amounts to money that is not in your bank account.
The challenge with many 'early bird discounts' is that clients don't seem to really care much about them. How many of us have paid a credit card bill early with the promise of cash back? Not many, and that's because we're hardwired to keep cash for as long as possible.
A traditional early bird discount in the agency space looks like "5%, 15, net 30," which means that your clients gets a 5% discount if full payment is made within 15 days of receipt of services and that full payment is required within 30 days. This traditional strategy works some of the time, but there are more innovative ways to reward early payments, which include:
Vanishing rewards that are meaningful and compelling to clients who pay their invoices by a certain date. If paid on time, the client gets free access to a paid activity like a webinar, event, research study results, etc.
Offer a discount for future projects (not a big fan but I feel the need to mention it as an option).
Offer an evergreen product that you've created e.g., a book or a white paper. Feel free to get creative here.
3. Make It Hard for Clients to Pay Late
You have to create a framework that rewards the behavior that you want and penalizes behavior that is detrimental to your cashflow. I know this is more easily said than done, especially because it is often your biggest clients, that are the slowest to pay. Here are some ideas to make it hard for clients to pay you late:
Discounts for pre-payment. Offer a discount for clients who pay before you start doing the work. Think about offering discovery sessions.
Freeze work if payment is not received by a specified number of days after it is due. I've only seen a handful of agencies ever freeze work for late payment. But I continue to push it as a tactic because it forces your client partner to get tough with their accounting department.
Compound late fees. This means the interest keeps building at agreed upon dates the longer it takes to receive payment.
KEY TAKEAWAY
One of the best ways to improve cash flow for your agency is to reduce the time it takes to receive payment from clients after services have been rendered.
A high DSO, anything over 45 days, is a signal that your agency is experiencing delays in receiving client payments. Once you start creeping above this number, it leads to disruptions in your accounts payable. Keeping track of your Days Sales Outstanding in your Agency Scorecard is an easy way to spot trends and stay ahead of any potential issues.
Last but not least, many of you provided generous payment terms to clients throughout the pandemic. It may be wise to review and restructure those payment terms.