What’s Your Risk Tolerance for Unpaid Invoices?

Have you ever heard of the boiling frog theory?

It goes like this: if you try to put a frog into a pot of boiling water, they’ll hop right out. But if you put them in lukewarm water and gradually increase the temperature, by the time the water is boiling they won’t jump out.

It’s a bit morbid, but it raises an excellent point: sometimes, we don’t have time to stop and think about something that’s negatively impacting us until it’s too late.

Now, think about your unpaid invoices as that boiling water. Our research shows that 62% of businesses send over 100 invoices to customers each week. With so many invoices to keep track of, it’s easy for one or two late payments to slip through the cracks. And from there, the number of late invoices can easily increase.

Yup, you guessed it: that makes you the frog.

So, what’s your tolerance level? How long are you really willing to wait for money you already earned?

Late payments are more than a nuisance; they’re a drain on cash flow

According to our latest research, 81% of businesses reach out to customers between one and four times for a single unpaid invoice. Think about the time that takes. Now multiply that by the number of overdue invoices you’re chasing each month. That’s a whole lot of hours you could have spent on strategy, forecasting or strengthening customer relationships. Instead, you’re stuck in collections limbo.

Now consider this: 66% of businesses said they’re waiting on up to $70,000 in overdue payments each month. That’s not just a line on a spreadsheet. That’s real money you need to keep your business running smoothly. You could use it for so many things – paying your employees, buying materials and supplies for customer orders, paying for operational expenses like rent and electricity, paying down your debt and so much more.

This isn’t just about tolerance anymore. It’s about survival. So why would you put up with it? Well, like just about everything when it comes to customer relationship management, it’s nuanced.

Credit risk data is more reliable than blind trust

The good news is that more companies are doing the necessary credit due diligence to make sure they’re signing customers who have strong financial health and don’t pose too much of a financial, legal or compliance risk. But what about a customer you’ve been working with five years – and have a great relationship with? Turns out it’s not all that simple.

An anxious business meeting between three coworkers in an office

What we’ve found from our own research is that many companies feel conflicted about running a business credit check on longstanding customers. Maybe you feel like you’ve got a good rapport with a customer and trust them based on their past payment behaviors. But just because a customer previously paid you on time (or close to it) doesn’t mean that’s always going to be the case. The reality is, circumstances change. They may have taken on significant long-term debt more recently – and that is now part of their monthly payment priorities. Or they might have lost a major contract from another customer – which accounts for roughly 40% of their total annual revenue. If any of these things are happening in the background, then you might fall further down their payment priority list. And you know what that means? Your cash flow is going to take the hit.

Now, I’m not saying you shouldn’t build trusting relationships with your customers. But you can’t let your trust override the need to use credit risk data to make the right decisions for your business. If the aforementioned things were happening with one of your longstanding customers, you’d likely want to consider re-negotiating their payment terms. So, if you had previously agreed to 60 or 90-day payment terms, it would probably be in your company’s best interest to shorten that to 30 days. At the end of the day, keeping your cash flowing and prioritizing collections are your responsibility. Blind trust won’t do anything to help you do your job.

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5 tips to improve your risk tolerance for unpaid invoices

Segment portfolio by payment behaviors: It’s important to know which customers are paying late and which ones are paying on time1. . If you don’t know this information, your Accounts Receivables can become unorganized and ineffective. The best way to do this is to set up portfolios that you want to monitor so you can be alerted when anything changes in their business credit report. For instance, if a customer’s DBT rises above a certain threshold (let’s say 60), then you would get an alert. This would allow you to make decisions in real-time based on the information you’re seeing.

Identify causes of late payments: Once you’ve identified which customers pose the greatest risk to your cash flow and revenue (i.e. frequent/increasing late payments), then you should investigate what’s causing those late payments. Is a customer repeatedly paying late because of invoice errors made by your own team, which then require corrections and lead to delays in reviewing and processing? Is a customer facing cash flow issues and making the decision to pay you later so it can prioritize repaying debt or paying employees’ wages? Or is a customer strategically paying your invoices late so they can keep more money in their account for longer? These are a few of the questions you need to ask so you can fully understand what’s causing late payments. You need to know whether it’s happening because of operational inefficiencies or errors on your side, or if it’s the customer’s fault. You can’t fix what you don’t know is broken.

Set automated alerts for overdue invoices based on your tolerance level and cash flow: Take advantage of technology by creating automated alerts for overdue invoices. Set the criteria and parameters for these alerts based on your tolerance level and current cash flow position. Know what your company is willing to put up with and how long you’re willing to wait for overdue invoices to be paid. And make sure you set some limits on the maximum value of unpaid invoices you’re willing to tolerate from a customer. You know your cash flow more than your customers. You need to set the limits accordingly.

Charge late payment interest: What if you’ve reached out to a customer over 5 times in the last two months, chasing after unpaid invoices? And what if the customer still hasn’t paid your invoice? Your cash flow is going to be affected – and not in a good way. One thing you could do to encourage them to pay on time is charge them late payment interest fees.

Re-negotiate payment terms: Payment terms are there to protect your cash flow. And they don’t have to be so rigid. You can and should change them as the circumstances of your customers change. Let’s say you agreed to a Net 90 payment terms with a customer when you first started working with them. This decision was made based on the financial due diligence you did back then. Now, let’s say it’s now the second year of working with this customer. But in the second year, this customer owes you a significant amount of money in unpaid overdue invoices (over $250,000) and has consistently paid late for the last 12 months. This could warrant re-examining their contract and adjusting their payment terms to Net 60 or Net 30. The point here is that you shouldn’t feel locked into payment terms with your customers. Their financial circumstances are likely to change regularly depending on various factors that could lead to declines in revenue and cash flow, while debt and operating expenses increase. You’re responsible for keeping your company’s cash flowing so it only makes sense to adjust the payment terms when customers fall behind on paying you.

Improve your risk tolerance for unpaid invoices

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About the Author

Lina Chindamo, Director, Enterprise Accounts, Creditsafe

Lina Chindamo is a Certified Credit Professional (CCP) with over 25 years of experience in credit risk management. She has held senior leadership roles with leading companies in multiple industries in the Canadian market such as Sony Electronics, Maple Leaf Foods, and Mondelez Canada. Her experience as a credit professional along with her current role as Director, Enterprise Accounts who works closely with c-suite partners and credit teams across all industries makes her a well-rounded credit professional who is well respected in our industry.