It's Not Revenue If You Can't Collect It

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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There's nothing worse than having to chase down slow-paying customers. Oh wait, there is something worse: the ones who don't pay at all.

The best strategy for dealing with bad debt is to not let it go bad in the first place. Here are some tactics that will help.

1. Check their credit

At the very least, you should check a prospective customer's credit report and credit score. For small businesses, Dun & Bradstreet, Experian, or Equifax are the major reporting agencies. Among the three agencies, Dun & Bradstreet is the oldest and most established in the business market.

Depending on the size and age of the business, these reports will include information such as their bill payment history, whether there are any outstanding liens or judgments against them, the size and nature of their loans and credit lines, levels of credit extended to them by other companies, balance sheet and income statement data, and any recent payment trends. How they've paid their bills in the past is the best predictor of credit worthiness.

While sample reports are available on each of the agency web sites, it's important to note that not all credit reports are as thorough as the samples offered. Little to no information may be available on smaller and newer businesses.

If you're selling to individuals, the primary reporting agencies are Experian, Equifax, and TransUnion.

Since business life is anything but static, recheck your customers' credit on a regular basis or sign up for alerts that warn you when something changes.

It's worth noting that mistakes in credit reports are quite common, so unless you see a pattern of problems, you might want to question a potential customer if an item or two seems atypical. You should check your own credit reports regularly for this reason, too.

2. Require and check credit references

If you don't have a formal credit application, get one and use it for all customers who aren't on COD terms. A Google search on "sample business credit application" will offer many free templates.

But just having a prospective customer fill out the application isn't good enough. Be sure to request recent business credit references. Specify that none can be related to the applicant. Include a disclaimer that allows you to check with industry contacts other than those provided.

When you call their references, you'll want to confirm the prospect's credit limit, the vendor's payment terms, the general payment experience, how long they've worked with the prospect, and the date of the last sale.

If the reference doesn't want to talk, be suspicious.

A word from the lawyers: Have a local business attorney review your credit application and tell you what is and isn't legal to ask. This is especially important when dealing with individuals.

3. Establish and enforce credit limits

Decide what level of credit you're willing to extend based on what you learned from the credit report, the references, and your own level of financial comfort. Once they're set, enforce them.

4. Make your credit policies obvious

Make new customers aware of your credit policies and payment terms. Remind existing customers with a statement on each invoice. Establishing and enforcing your late payment penalties will let your customers know you're serious about being paid on time.

5. Tighten requirements on questionable customers

Small business lenders require personal guarantees and collateral. Why should you be an unsecured lender? If times get tough, the secured creditors are first in line (though the bank will no doubt be in front of you).

If all else fails, require cash on delivery.

6. Use accounts receivable (A/R) agings to continually monitor who owes you money

At least once a week, look at who's past due. The sooner you do something about it, the better chance you'll have of being paid. At the very least, give them a call. If it looks like a real problem, you may want to suspend their credit, require COD, or stop selling to them altogether.

7. The squeaky wheel gets greased

Small business owners are often illogical about who they pay when cash gets tight. The more constant the dialogue, the more likely you are to be paid.

8. Consider legal action

If all else fails, you may need to consider small claims court, a collection agency, or a full on lawsuit. Be sure to weigh the costs against the benefits of such actions. Even if you win, there may be nothing to collect. Sometimes, while you may be angry, it just isn't worth it. If that's the case, write it off — both figuratively and literally — and learn from the experience.