In my nearly 20 years of working with small and medium businesses, one thing that I’ve consistently seen is how susceptible service-based businesses are to bad debts when compared to those that sell goods.
When you think this through, it does make sense. As a business owner when you sell a good to your customer, you’ll rarely hand it over until you receive payment. This way you can protect your revenue stream by withholding the product. The business is also potentially able to sell that same product to someone else if the original sale falls through.
Service-based businesses however don’t always have this same protection mechanism as they’re usually selling a person’s skill and labour.
Even when this service accompanies the supply of a tangible product, there’s often a large component of time invested in the supply that can’t then be easily recovered simply by selling it to someone else if the original customer doesn’t pay.
This requirement in a service industry to invest large amounts of time and physical labour before the “job is done” can leave the business not only at risk of getting paid late, but at risk of never getting paid at all. If this happens enough to a small business, it may find itself in serious financial stress with a huge Accounts Receivable balance.
how can you protect your revenue + cashflow?
The good news is that service businesses can do multiple things to protect their revenue and cashflow by:
having detailed contracts or engagements for their work
The best way to safeguard your position is to have a clear contract or service engagement with terms and conditions. These agreements help to set clear expectations for both your business and your clients. At a minimum they should:
- List the services to be provided and a timeline for delivery.
- Detail how much you will charge for the service [whether a fixed fee or an hourly rate] and how often you will charge.
- Detail payment terms and invoicing procedures.
Tip: Having these details in writing helps to mitigate the risk of dispute over invoicing, payments and deliverables.
As a business owner you should also ensure you update your engagements if the scope ever changes. This will ensure your agreements and contracts are up to date and current.
performing credit checks for large projects
For business owners, the more information you have about your clients, the more informed your choices can be when deciding what clients to work with and how to engage with them. Performing credit checks on your clients helps you assess the financial health and credit worthiness of your clients before entering a business relationship with them.
A credit check will provide details including payment habits, outstanding debts and credit score. This information helps you assess the risk of non-payments or late payments which will help you decide whether you work with this client or what invoicing and payments terms you should apply to their engagement agreement or contract.
If after your research you discover the client may be risky, this doesn’t mean you have to say no to working with them, but you should put the mechanisms in place to protect yourself [like including regular invoicing and tight payment terms to name a few]. In fact, you should do this regardless of the risk associated with the client – as you never know what may happen in the future.
Once your agreements have been signed and you begin to deliver work, your invoicing needs to be consistent and regular to minimise any damage if your client can no longer pay you. The more often you invoice and get paid the better. You can identify clear milestones for raising invoice, these can be either time bound [say every month] or based on milestones or deliverables.
Regular invoicing will ensure that you have a steady stream of income and will reduce the risk of nonpayment by not waiting till the end of a job, particularly if you are being engaged to perform a service that may take several months.
Invoicing regularly also provides you with an opportunity to communicate with your clients. Your invoicing can include details about the work completed and provide a progress update. This keeps your clients informed and engaged! After all, prioritising engagement of both newly onboarded and existing clients increases sales, promotes branding and strengthens loyalty, so it’s something you want to commit to.
If you find you’ve underquoted a job, don’t panic. It’s an easy mishap to correct by simply [and quickly] communicating with your client. This way, your client won’t be in for a surprise if an invoice is higher than what was expected.
Ensure there is a mechanism to do this in your engagement letter and you can vary the fee if during the engagement changes are made known [or circumstances change]. Surprise invoices often hang around longer in the debtor ledger, as clients were not prepared to pay for them.
If you find yourself in the unfortunate situation where a client has stopped paying you [but you still have work deliverables], you may consider stopping work until your outstanding invoices have been paid. Deciding whether to stop work will depend on your circumstances, the length of the client relationship and your contract terms.
Before stopping work, you should always review the terms outlined in your engagement agreement or contract with your client. If your contract details payment milestones, deadlines, or terms, you can evaluate whether the client’s non-payment is a breach of the agreement. In some cases, you may have the right to suspend work until payment is received.
Before taking any action, you should always communicate with the client about the outstanding payment. It’s possible that there could be a misunderstanding or a valid reason for the delay. You may also consider offering alternative solutions, such as negotiating new payment terms, requesting a partial payment upfront, or reaching a compromise that allows work to continue while addressing the payment issue.
taking payment details upfront where possible
Another great way to mitigate risk of non-payment is to take payment details from you client upfront using a merchant facility. If you operate a fixed fee business, taking payment details should be a fairly straight forward process. If you’ve already confirmed the price for services, explained your payment terms and your client has agreed, it should be smooth sailing in taking payment details and having control over your cashflow.
If you operate on a monthly recurring fees basis, where you invoice a recurring amount each month [similar to a retainer arrangement] then being in control of the payments process is a must. You never want to find yourself in a situation where you’ve agreed upon a monthly fee, are supplying ongoing services to your client, but they’re failing to pay you.
By taking your clients’ payment details upfront and automatically processing their payments each month, you’ll ensure that your cash flow never suffers. Plus, you can also avoid the unpleasant situation of having to temporarily put a halt on work when your latest invoice hasn’t been paid.
Taking payment details upfront is a similarly useful strategy for clients who operate on a bill on completion basis, whether fixed fee or time billing. For fixed fees, the process is quite simple as you have already agreed on a price. If you operate using time-based billing, you can still do this. Simply provide your clients with a price range or an hourly rate, all of which can then be billed on completion once the work has been finalised.
You can also eliminate push back from your clients on this by implementing a policy of taking payment on the due date of the invoice as opposed to the date you raise the invoice. This will allow your clients to raise any questions that have between the job completion date and the due date of the invoice. This will provide enough transparency and clarity to make them comfortable.
Once you have implemented practices to protect your revenue and cashflow in your service business, you may wish to consider if you are charging enough for your services. If you would like to learn more about how to price your services, stay tuned for the next article in our professional service series.
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