If you extend credit to your customers, sooner or later you’ll have trouble collecting unpaid bills. Your first goal, of course, is to get paid. A second goal is to avoid legal problems and unnecessary expense in the collection process. And you also may want to be able to do business with the slow-paying customer in the future, if possible.

Extending credit will never be risk-free, but you can reduce the risk by screening those who apply for credit, especially where larger sums of money are involved. Make sure the credit terms are clear. The customer should know when payments are due, how much is due and what penalties will result from late payment.

Many debtors give priority to bills that bear interest or service charges. Your lawyer can tell you how much you legally can charge in your state and how to set up the account.

Precautions up front

When you first extend credit to a customer, get his or her signature on a credit application that explains the terms of payment. In addition, get the customer’s address and phone number for both home and at work. That will make it easier to get in touch if payments aren’t made.

If you extend credit to a small corporation without a proven track record, have owners co-sign the credit application as individuals so that they will be personally liable if the corporation later goes broke.

If there’s a credit bureau in your city, consider ordering a credit report. This can help you avoid getting in too deep with a customer who had payment problems in the past. As you continue to do business with a customer, try to get signed orders for services, or at least get a receipt, so that you can later verify that the service was performed.

Accepting credit cards is a good form of protection. This transfers any collection problems to the bank issuing the card. Such convenience doesn’t come free – you must decide whether you have enough collection problems to justify the credit card fees.

Overdue bills

Let’s assume your company has extended credit directly to a customer and that no credit card is involved. What do you do if the bill is overdue? Prompt action is essential. The longer you wait, the harder it will be to get paid in full. Let the debtor know that you intend to pursue the matter and that you expect payment in accordance with your usual policies.

Develop a set of three letters that escalate in urgency. Your first letter can be a simple request for payment. You might suggest that perhaps the bill was overlooked. Encourage the customer to send payment immediately to maintain a good credit rating.

The second and third letters should be polite, but increasingly firm. In the third letter, state that if payment isn’t received promptly, you plan to take collection action.

Vary the format of your letters. Each one should look a little different. Avoid letters that look like form letters. Mention the specifics of the transaction, including the service the customer bought. And remind the debtor that continued delay means you’ll assess further interest and late payment charges.

Have the letter signed by a responsible company officer. Provide a return envelope to make payment easier. Suggest that the customer contact you immediately if there’s a problem that will cause any further delay in payment. Occasionally, you may wish to follow up with a telephone call or certified letter. That will get the debtor’s attention.

Don’t push too hard

But be aware that if your collection efforts get too aggressive, the debtor may sue you. Your lawyer can give you specific guidance on collection practices that can get you in trouble in your state. Generally, you should avoid calling debtors late at night or early in the morning. Some state laws specifically say that unless you have the debtor’s permission, you should make phone calls only between 8 a.m. and 9 p.m.

Be careful not to mislead or deceive a debtor by writing a collection letter on a lawyer’s letterhead or credit bureau stationery. Don’t contact the debtor’s employer unless the person has given you permission in advance. However, it’s usually all right to contact the employer if you’re only trying to locate the debtor or verify his or her employment.

What if you’ve extended credit to someone and, despite all your efforts, the bill remains unpaid? At that point, you can turn the matter over to a collection agency or a lawyer. Another alternative is to proceed in small claims court yourself. That way, if you get a judgment and collect, you won’t have to share the proceeds with a collection agency or a lawyer.

When to write it off

Procedures in small claims court are simple and speedy. Court personnel are usually able to help you complete the papers. But obtaining a judgment is just the first step. You must still collect on it.

The most practical way to collect is through garnishment. This allows you to reach into the debtor’s bank account to collect the money or to require the debtor’s employer to pay it to you out of wages. That’s why it’s important to get as much information as possible up front about bank accounts and employment.

There are other methods of collecting a judgment, such as going after the debtor’s real estate or personal property, but these are much more complicated procedures and generally less productive than garnishment.

As a rule of thumb, if you can’t collect the debt from bank accounts or wages, you should consider cutting your losses by writing off the debt. Some unpaid bills are hopeless. It doesn’t pay to spend your time, money and energy chasing after bills where the chances of recovery are practically nil.