Manage late payments: 5 Step Process
Ability to improve payment cycles can be such a real gain for businesses, especially SMEs. In this article, we will explore steps to manage late payments.
1. Identify and quantify the problem
In order to manage late payments, first we need to identify and quantify the size of the current late payment problem. For example:
On average, 30% of invoices are outstanding as of due date, costing the business an equivalent of $40,000 a year. This includes time and costs associated with the collection process, missing out on sales opportunities and funding costs.
2. Analyse the late payments problem
After identifying and quantifying the issue, businesses will then need to analyse the root cause of the late payment problem.
One method that can help SMEs to identify the root cause is the ‘5-Why’ technique. For example:
1. Why are customers late in making payments?
Lots of manual process and communication between parties are required before payments can be made.
2. Why?
Payment instructions on invoice document is not clear to customers i.e. customers do not know when the payments is due, and payment instructions are unclear or not available.
3. Why?
We don’t have a system/process in place to generate invoices with relevant/correct information. Manual processes which are prone to human error.
In the above example, 3-Why was sufficient to understand the root cause. Let’s take you through another example:
1. Why are customers late in making payments?
Some industries take longer than others to pay, especially Marine and Construction industries.
2. Why?
- The average payment terms in the Marine industry is approximately 90 days but our payment term is 45 days.
- There are no penalties for late payment
3. Why?
- We need cash within 45 days to pay our supplier
- We can’t implement late payment penalties as they are our largest customer.
4. Why?
- We agreed to pay our supplier within 60 days of invoice date.
- We will lose our customer
In this example, 4-Why was sufficient to understand the root cause.
There will always be multiple reasons that lead to late payments issues. It is important go through each of them.
3. Design and prioritise solution
Once SMEs understand the root cause, the next step is to design solutions to tackle them.
Each solution must then be prioritised based on:
- Effort: how much effort (resource and time) is required to implement the solution
- Improvement: how much of an improvement SMEs expect to see (in $ terms)
- Criticality: can the solution resolve the most critical/urgent pain point
Usually quick win solutions are good ones to start with to help SMEs gain the benefits as early as possible.
4. Implement Solution
SMEs to implement the solution based on priorities in (3) above to manage late payments.
5. Verify the result and continuously refine the design/implementation
The final step for SMEs to manage late payments is to monitor the outcome. It is very important to analyse whether the identified solution actually resolved or reduced the issue that SMEs identified in the first place (i.e. expenditure of $40,000 due to late payments – step 1). Continuously refining the solution based on what works, what does not work to achieve the ultimate outcome to manage late payments.
