Accounting for a successful debt collection is a slightly trickier transaction than most people are used to, and there are actually a couple ways to handle it.
It's important to understand that even if a vendor says they will pay their invoice, it doesn’t mean that you are going to get paid the full amount. In many cases, a collections agency will charge between 25-35% of the collected amount of debt, depending on a number of factors. While this may seem steep to some, remember that this is income that you are no longer expecting, and if you weren’t sending to a collections agency then you would be writing off the entire amount.
When we receive a payment from the collections agency, we will first record the full payment that the customer made to the agency. We will then go into undeposited funds, select the payment, and then go to the other funds section and deposit a negative amount to "Professional Fees" or "Bad Debt Expense" for whatever the collections agency charged. This will go against the total payment, and net you the correct amount you are depositing. This will clear out your Accounts Receivable, and properly record the collection agency fees.
Here’s an example:
Jim's Lobster Shanty finally paid up after sending them to collections. They offered to pay their $2,500 invoice in $500 increments, since that is all they can afford. That means that there will be a $500 payment for each of the next five months until the invoice is fully paid. You agreed that the collections agency could charge a 25% collections fee on this debt if they could get it collected.
Each month, you are going to receive a payment from Jim's Lobster Shanty for the full $500 to undeposited funds. Once in the undeposited funds window, check off the payment, and go to the bottom, and record a negative deposit of $125 to “Bad Debt” for the collections agency fees.
A QuickBooks Online Debt Collections Workflow (Yay!?)
I am just going to go out on a limb here and say debt collection is not fun. Calling customers who just aren’t paying, are avoiding you, or are always telling you that “the check is in the mail” is infuriating. It is enough to drive even the most calm and collected person up a wall.
Worry not, here are a few steps you can take to make sure you’re not giving away money to the collections agency, but making sure you sending out your debt:
My recommended workflow is to set up a custom AR Aging report that has a 15 day aging period with 7 periods. This will give you a decent overview of how old the debt is, and this is going to give you the 7 steps toward sending these clients to collections, or as we like to call it, “the danger zone.”
Make sure you record all of your interactions with the client in a spreadsheet, or in the note section of the customer profile in QuickBooks Online. If you later have to send the account to collections, you can give this information to the debt collector, because the more information they have, the more successful they will be.
The Seven Steps Towards the Danger Zone
- 1-15d: These clients are likely just disorganized and will likely pay soon, the percentage to pay is still quite high, so you may just want to send them a reminder email / statement from QBO.
- 16-30d: Send a reminder statement from QBO
- 31-45d: Call the clients and ask about a payment. Ensure you record everything they say, especially if they promise to pay, or as the pros say “PTP.” You should be nice, but firm, in this call. The client should not feel threatened, but should know you are serious.
- 46-60d: Perform a follow-up call. If they say they are going to pay, offer to take their payment via credit card or ACH, or you can send a QBO invoice via email so they can do it themselves (if you do not have this feature enabled already, do so, as there is hard evidence that it will cut down on days to pay by heroic numbers). Tell them you would really like to continue to have a business relationship with them. This let them know you are now, very serious about this, without threatening them, and theoretically keeping the relationship alive.
- 61-75d: At day 61, send out a demand notice. Here is an example demand notice we use for our clients. If they don’t reach out to you within the date defined, give them an additional 3-5 business days and then send them to collections.
- Send them to collections. No, that doesn’t mean maybe, that means send them to collections. Business owners always have that little glimmer of hope that maybe, just maybe, the customer will see it in their hearts to just make a payment out of the blue. I’m sorry to tell you this, but it isn’t going to happen. Don’t take their calls anymore. They are no longer your customer. You don’t know them, they are dead to you. I promise you, it is the most liberating feeling sending these people off to the danger zone.
- Move to another balance sheet account (see below).
Once the account is in collections you can hang it up somewhere else on the balance sheet, such as an Other Current Assets account called “Allowance For Doubtful Accounts,” if you want to separate the totals. I don't use another Accounts Receivable account in QBO because they function so weirdly. We don't write off the balances until the collections agency says that it is uncollectible, but that’s because our Invoicing clients aren’t that big. If you are dealing with millions of dollars worth of invoicing, you may want to take this step. Instead, once we have sent a customer to collections, we will put an asterisk (*) at the beginning of the display name to symbolize that they are now in the danger zone.
Now sit back and relax, knowing CollBox is going to take care of all those deadbeats that used to stress you out.