I Give Up! Can Someone Else Collect My Money?

This article is co-written by Anders Liu-Lindberg and Jesper Mose Jensen

That’s it! I’m not spending any more time and energy trying to collect my money from this customer. All my dunning efforts have failed so I just give up. Hold on. Finance Masters never give up on getting paid even when dunning doesn’t work. They have a very last resort called Debt Collection. Granted, you don’t have to be a Finance Master to use a debt collection agency, however, there are still various approaches to this and in a follow up to Jesper Mose Jensen’s and my article on dunning titled “Finance Masters’ Last Resort To Get Paid” we go deep into the ways of using debt collection. You might remember that Jesper is developing financial accounting software as a Product Manager at Comarch - a global producer and provider of IT services and solutions. He previously worked closely with customers to optimize debt collection at Intrum Justitia – a leading European debt collection agency. 

The simple goal of debt collection is, to get paid on overdue invoices at the lowest cost possible and there are several parallels to the dunning process. Let’s start by making sure that there is no confusion about the three parties involved in debt collection; these are defined as the first step. 

• The debtor is the company or the person owing the debt – typically overdue invoices, which they have not paid for some reason.
• The creditor is the company having issued these unpaid invoices. It is from this point of view this article is written.
• The debt collection agency (DCA) is the company who has specialized in collecting debt from the debtor on behalf of the creditor.

Interests are not aligned

When a creditor is working with a DCA to collect on overdue invoices the first problem is that the interests of the involved parties per definition cannot be aligned. The debtors would rather be without the debt collection as this dealing with this takes time and is costly. The DCA makes a profit from collecting (an often used revenue model is that the DCA gets a share of the debt collected) and therefore benefits from a bad reminder process before debt collection. This is of course not in the interest of the creditor, whose profit is maximized if the debtor pays on time without involving a DCA. This conflict should be kept in mind when working with a DCA.

Revenue agreement with the DCA

What kind of agreement should then be made with the DCA? As with the reminder process, one would need to distinguish between creditors with a small number of invoices but for large amounts and creditors with many invoices but for small amounts.

If the number of invoices going to debt collection is so small, that they can be handled manually, the often-seen solution is to have the “house” lawyer handle it with limited system support. This makes sense as the set-up costs are very low, it is very flexible and it supports an individual treatment of the cases. A fair revenue model, in this case, is paying the lawyer per hour as big cases are often complex and a fixed price per case or a model where the DCA only gets a share of the amount collected will have to include a substantial risk premium for the lawyer making it more costly for the creditor in the end. The story of the small number of cases ends here as the following challenges are not an issue when the number of cases can be handled manually. 

If the number of cases is larger than can be handled manually (and then typically for relatively small amounts) it is an entirely different game. It is highly recommended to work with two or three DCAs in parallel. This gives the flexibility to compare performance and distribute new cases to the best performer. In addition to this “stick element”, the revenue model should also include a “carrot” for the DCA. A very basic but effective component is sharing the amount collected by the DCA. 

As with the dunning process, it should be considered that the debtors may be turned into profitable customers again. If a debtor is for instance willing to start a payment plan to pay off the debt and the creditor has a high contribution margin on the products sold (for instance on-line services or magazine subscriptions) it should be considered starting to sell to the debtor again with a very limited credit line. In addition to this, it should be mentioned, that it is not necessarily optimal to have a very small number of debt collection cases – again it depends on the contribution margin on the products sold. 

How should the performance of the DCAs be measured?

Be sure to measure the performance of the participating DCAs on a regular basis. Preferably measure on the data in your own system and not rely on the DCAs measurement of own performance. This ensures that it is done equally for all DCAs. If you are working with three DCAs, a model could be to guarantee each of them 10% of the new cases each month (the DCAs also invests in the set-up and this will guarantee a minimum of business) and then splitting the remaining 70% according to actual performance. When choosing (and later evaluating the performance of) a DCA, there are several factors to consider. You definitely do not want a social media shit storm if the debt collection agency is being too aggressive towards the debtors. It should therefore beforehand be defined how the DCAs work the cases. If you are working actively to get some of the debtors back as good customers this should be supported as well. Cash is, however, still King so the main component should be a measure of what is collected. An easy model to use is to split the cases in portfolios with a basis in which month the cases were sent to debt collection. On this aggregated level take the sum of all incoming payments and compare it to the original debt sent to debt collection. In this way, a collection percentage can be calculated per relative month. 

Data Exchange: The Devil is in the Details

When sending a debtor to debt collection you give up control to some extent. The communication is between the debtor and the DCA and you cannot be sure, that the balances in your accounts receivables system are correct. Actual hopefully it is not; as this means that the debtor has made a payment to the DCA that you do not know of yet. To make sure that both creditor and DCA are up to date on the debtor’s transactions a daily data exchange is preferable. This is where the DCA informs of incoming payments and which invoices they settle. In the same way, the creditor informs about new invoices, credit notes, payments and other transactions. On a single debtor level this is no problem, but when dealing with thousands of debtors with many more unpaid invoices, it is a challenge. The data exchange needs to be very well specified and executed very precisely. In addition to this, an automated check that the debtor balances in the creditors' account receivables books are identical to the debtor balances in the DCA’s collection system is a minimum. Even better is an automated reconciliation of each debtor's open items (invoices, credit notes and so on). In this way it is ensured, that potential problems can be dealt with immediately. 

Why not sell the debt collection cases and cash in immediately?

A convenient solution is also to sell the cases instead of bothering with debt collection. In most cases, it is not a good idea. The reason being that the creditor knows the cases the best and a third party will require a risk premium (and therefore offers a lower price) to compensate for this lack of insight. There are of course exceptions. Buying a portfolio of bad debt cases is essentially a gamble on the development of the economy. If things are getting better, bad debtors become better debtors and are more likely to pay what the owe and vice versa. If you expect a coming recession but the potential buyer expects the opposite, then selling is probably a clever idea. 

At the end of the day, everyone wants to get paid but when complications arise you need to carefully evaluate every stage-gate that the debtor goes through. Each escalation is a potential deal-breaker for the relationship with the debtor. Sometimes that’s alright if you don’t expect to do business with them again but these decisions shouldn’t be made lightly. Finance Masters are fully aware of their options for getting

You're the Master and your input is needed! 

The Finance Master series is looking for your input as well. What advice do you have when it comes to using a debt collection agency? Have you been able to turn a customer relationship around after you turned it over to a collection agency? We encourage you to add it all in the commentary field and Anders will update the article as they tick in. If you disagree to some of the statements in this article what would you do instead? Finally, if you want to be a part of the Finance Master series then send Anders a message or write in the comment section with a topic you think that you master.

This is the eleventh instalment in the new Finance Master series and you can read the kick-off article here and previous instalments below. Let us know what you think of it by liking, commenting and sharing so we can spread the Finance Master message to all finance professionals. You can follow Anders on Twitter for continuous updates about what’s happening in the finance function.  

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Anders encourages you to take a tour of his old posts on finance transformation and not least “Introducing The Finance Transformation Nine Box” which is really the starting point for the transformation. Finally, you should join the Finance Business Partner Forum where we will continue to discuss this topic.

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Anders Liu-Lindberg is the Head of Global Finance Program Management Office at Maersk and has more than 10 years of experience working with Finance at Maersk both in Denmark and abroad. My main goal at Maersk is to create a world-class finance function not least when it comes to Business Partnering. I am the co-author of the book “Skab V?rdi Som Finansiel Forretningspartner” and a long-time Finance Blogger with now more than 17.000 followers.