Nothing reduces a business's cash flow like unpaid bills. Particularly in a small business, tracking down the guilty parties is both a financial and physical drain.

To recover owed money, many businesses turn to collection agencies. These organizations specialize in collecting payment from overdue accounts.

Most firms bring in collection agencies for debt that is about eight months old, although a few bring in agencies after only three months.

This guide is designed to give you the facts you need to hire a collection agency for your business. You can choose to read this guide from beginning to end, or jump directly to a section of interest.

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Collection agencies can attempt to collect on bad debts in two ways:

By mail and phone

For larger debts, they will typically send letters and make phone calls to the delinquent account.

By mail only

Smaller debts may not justify the cost of phone calls, limiting the collection agency to simply sending threatening letters.

Choosing a collection service is tricky, since it's hard to predict a firm's success with delinquent accounts ahead of time. A few areas to investigate when choosing a collection service:

Method of collection

You should examine the letters that will be used and judge whether they will be effective with your customer base. Also ask about the training that telephone collectors receive to ensure they understand the Fair Debt Collection Practices Act.

This 1977 act requires that debt collectors treat debtors fairly by prohibiting certain methods of debt collection.

How the service will work with you

Be sure to find out:

• how information about delinquent accounts will be transferred to the agency.
   
• when collected funds will be forwarded.
   
• what reports are provided detailing the collection progress and success rates.
   
• how you can stop collections if you receive payment or credit an account.

How they handle skiptracing

This is particularly important when collecting from individuals. Skiptracing refers to how the firm finds debtors who have disappeared and can no longer be directly contacted. Agencies should have access to online search capabilities and telephone databases to help locate these debtors.

Reputation of the firm

Make sure to check references, particularly from clients that are in a similar business. Also find out whether the firm complies with state licensing or bonding laws.

There are several actions you can take to reduce the amount owed to you before resorting to an agency.

Be careful when offering credit

Carefully check credit references of each new account and don't extend more credit than the firm can handle.

Explain transaction terms thoroughly

When extending credit, make sure that accounts know when you expect payment, and clearly detail any credits or penalties for early or late payment.

Follow up overdue accounts

Do not expect customers to police themselves; instead, make sure to promptly send statements and reminders of payment due dates.

Institute a series of overdue notice

You should schedule regular written and oral reminders before even considering a collection agency. This will not only help save money, but will also avoid the ill will that can be generated when using a third party to collect the funds.

Set an absolute due date and stick to it

As a final step, set an absolute due date before the account is turned over to a collection agency. Do not extend this date, but do give the debtor warning of this final payment date.

Debt collection is usually done on a contingency basis. This means that the agency keeps a percentage of money that is collected from a debtor. Depending on the size of the business, commissions can range from 10% to 50% of the recovered amount. Other agencies require an upfront fee and then take a lower percentage of the recovered amount.

The advantage of contingency billing is that you do not pay for uncollected debts. However, some agencies will not offer contingency services for small debts. In these cases, you will typically pay a fixed fee for a series of letters or calls.

When assigning a third party to collect an overdue account, provide them with all the information you have about the debtor, including an itemized breakdown of all contacts between your organization and the debtor's business or home.

Make sure the agency you choose is licensed

Some states require collection agencies to be licensed in their state before they can pursue debtors. Contact the American Collectors Association (612/926-6547) or a particular state's collection agency administrator for specific details on state requirements.

Get more than the P.O. box

To increase the agency's chances of tracking down an individual or business, always ask for the customer's physical address (even if you are sending the materials to a Post Office box), phone number and social security number. It can also help to work with a credit reporting agency. All of this information will be helpful in tracking down individuals even if they have closed their P.O. box or changed their address and phone number.