Money, credit & you: Mastering accounts receivable

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Most companies go out of business because they run out of cash. One of the biggest factors that can impact a business’ cash flow is how well they manage their accounts receivable. A well-oiled accounts receivable process can save you much pain down the road.

But first, let’s take a look at what accounts receivable is. Then, we’ll tackle how you can better manage it and get the most out of it.

What are accounts receivable?

By definition, an “account receivable” is created when a client makes a purchase but does not immediately pay for it. In effect, they take a loan from the company and promise to pay it later. This is typically repaid in 15 to 60 days. How soon money is collected on this debt will be a major factor in determining the company’s cash flow and the capital needed to run the business.

The optimal way to manage all accounts receivable and to boost a company’s cash flow is to not create the receivable in the first place. This is done by having the customer pay for the product or service when it’s delivered, mostly via a credit-card or online payment.

Remember, a line of credit is a privilege that should not be given to all clients. This is especially true for people who have never done business with the company. If a new client will not buy from a company because they can’t get credit, that might be a sale that should not be made.

Collecting payment at the time of sale may not be practical or customary in some industries, so any receivables need to be closely monitored. If a company does not manage them, the customer will set their own repayment schedule, which will negatively impact the business’ cash flow.

This is where you need to be wary of doubtful accounts. These are accounts that have outstanding debt and a poor payment history. These accounts typically owe a sizable amount of money and eventually become bad debt, which is debt that isn’t being repaid.

Optimizing accounts receivable

If accounts receivable sound messy and complicated, that’s because they certainly can be. Fortunately, there are things you can do to make sure you’re running a smooth operation. Here are the processes you must follow in order to optimally manage all accounts receivable.

1. Establish a ‘days sales outstanding’ (DSO) goal

How long does the company want to wait in order to get paid from their clients? The number should be as low as possible, but it’s typically between 15 and 45 days. This number will have an important impact on cash flow, so it should be set carefully.

If a company can’t get the expected cash from its accounts receivable, it may need to find it by other means, such as delaying accounts payable, reducing inventory, or borrowing from a bank. The DSO goal is important, because a bigger number means the cash flow requirements of the business increases.

For example, if a company achieves $90,000 of revenue per month and waits five extra days for a customer to pay (for example, the DSO goes from 40 to 45 days), it may need to find another $15,000 of cash to run the business. (The math is $3,000 per day multiplied by 5 days.) This can quickly add up when spread over a high amount of accounts and hurt you in the short-term and long-term.

Note: Don’t confuse this with “days payable outstanding” or DPO, another common accounting term. This is the amount of time a company takes to pay creditors.

2. Establish a credit policy

This should be a planned company process and not one that is decided by the accounts receivable clerk. It should keep the risk as low as possible and clarify:

Who gets credit

This should be determined by customer track record and checking a database like Dun & Bradstreet to measure credit worthiness. Also, keep in mind the potential value of accounts when thinking about whether or not they should get credit. Accounts that have the potential to bring in a large profit could be worth it.

How much credit is issued

This should be a low number to start. It should be less than the average historical transaction done by the company. Large first-time orders should never be given credit.

How long will the terms be

Having clearly stated payment terms in your service agreement is one of the most important steps in managing accounts receivable. Start with a 15-day payment deadline if possible, and extend the terms if asked by the customer over time. State a specific date that the payment is due, as leaving it open-ended will only result in the customer setting their own terms (this could mean never).

Follow the credit policy

Make sure that both the policy and process are followed. There will always be pressure from commissioned sales reps to extend credit.

Record accounts

Make sure you track the payment history of accounts that seek to apply for a new line of credit for another purchase at a future date. This can help you determine if an account is worth doing business with again. If the account has current liabilities, you should think twice about giving them credit that calendar year or in the near future.

3. Track payments carefully

Most clients want to pay their bills on time, but they might need help to pay within terms. To encourage timely payments, proactively call after the invoice is sent to make sure they received it and to ask when they payment might be made. Be sure to remind them of the account balance during the call to confirm how much they owe.

Follow up early and often to make sure the due date does not slip. Remember that every business has the right to be paid within terms, so don’t be afraid to ask for the money. If the payment is not received on time, immediately call to see why it was not sent and when it will be.

4. Charge interest on overdue payments

While the company may never collect this interest, it sends a signal to the client that the company is serious about getting paid. It can also be forgiven as a concession to the client once the invoice is paid. Interest is fairly standard on short and long-term debt, so most clients should understand. On the other end of the spectrum, make sure you thank those who deliver early payment.

5. Cut off credit to overdue clients

Information about overdue clients can be found on an accounts-aging report. Too many small business owners continue to extend credit to customers who pay their bills late. This only reinforces their delinquent behavior and increases the cash risk in the company.

Cash flow is the lifeblood of every business, and an effective accounts receivable policy is the heart of it. By keeping track of your accounts receivable, you can ensure you get paid for your services, maintain a steady stream of cash flow, and keep your business afloat.

One of the most important steps in managing accounts receivable is creating professional invoices and establishing reliable invoicing techniques.

7 Tips for managing accounts receivable

You know that cash flow management is essential for your company’s long-term survival. Most small business owners should know this, yet one in four small businesses struggle to collect payments from clients, while a whopping 43% have current invoices that are more than 90 days past due. This is where properly managing your accounts receivable comes into play.

In the long run, companies that can’t collect payment from their customers are forced to draw from their cash reserves or seek outside financing. As a result, owners have less cash to manage operations, pay employees, and ultimately grow their businesses.

While collection problems are clearly common among small businesses, owners don’t have to suffer delinquent accounts. There are steps a firm can take to better manage its accounts receivable and increase overall cash flow. You know how to optimize your accounts receivable, and now, it’s time to learn how you can manage it like a total boss.

1. Go electronic

If you want to expedite the invoicing process, consider sending bills via email using an email invoice template, instead of the U.S. Postal Service. While snail mail can cause your invoices to be delayed by several days, email ensures they reach the requisite party immediately. Just be sure to confirm your clients’ email addresses ahead of time, as you don’t want to complain about late payments on invoices that your customers never received.

Accounting software can also help you maintain a more accurate balance sheet, allow you to track your current assets, and even automate the reporting and sending of financial statements. In short, accounting software can be time-consuming but necessary work that comes with accounting. Your account payable clerk or clerks have enough on their plate. Go electronic, and take a load off.

2. Reduce payment terms

Reducing payment terms is one motivator, but it works even better if you do it over email. One of the many benefits of invoicing via email is that it allows companies to reduce their payment terms.

Because of the delays that accompany paper mail, businesses used to allow 30 days or more for payment. However, the immediacy of email invoicing means that businesses can now specify that payment be due upon receipt rather than 30 days.

As a result, you can collect on bills faster, ensuring sufficient cash flow for the coming weeks. Additionally, you should send your invoices as soon as a project is completed rather than wait until the end of the monthly billing cycles. This helps keep work “fresh” in clients’ minds.

3. Maintain a healthy work relationship

Happy customers are more likely to pay their bills on time. In the event that a customer is short on cash, they will likely prioritize the companies with which they have a positive relationship. If you want to avoid late collections, fulfill your obligations and develop strong working relationships with your business clients. A few personal calls to the payment departments can ensure you never wait on a late invoice again.

4. Offer multiple payment methods

If you want to get paid on time, give your customers as many options as possible to satisfy their debts. While sending a check each month is still commonplace, some clients may prefer to pay invoices via PayPal or credit card.

Additionally, you may want to consider utilizing electronic funds transfer (EFT), which allows customers to transfer payments from their bank accounts to yours for a fee, provided they have your bank name and account number. You may want to include this information on your invoice to make EFT an easy option for paying bills.

5. Consider hiring an accounting company

Managing your accounts receivable can take up a great deal of time and energy. One option for reducing workload while boosting cash flow is to hire an accounting company to handle your finances. By turning your accounts receivable management over to another firm, you can focus on what matters: running your business.

6. Set clear credit policies

If you’ve worked with a customer for years, you may be tempted to offer a credit on your products and services. Extending too much credit, however, can take a serious toll on your accounts receivable. Before setting up a credit account, check a business’ credit history to ensure it has a record of paying bills on time. Additionally, you should set up clear terms and inform your clients of all the details before any agreements are made.

7. Make collections a last resort

Still waiting for a client to make good on their bill? While you may be tempted to turn over unpaid invoices to a collection agency, it’s best to use this option as a last resort. After all, handing over accounts to collections can result in significant financial costs along with lost business. Before going this route, call the client personally to make one final appeal for payment. A bad debt can be painful, but the lingering effects of sending collections can hurt your reputation and result in lost business.

Keeping your accounts receivable healthy

There’s no getting around the fact that cash flow is a crucial element of overall financial performance. Managing your accounts receivable doesn’t just keep your business running smoothly. It helps ensure a long and profitable future for your company.

Keeping your accounts receivable up-to-date is crucial, but that’s not the only part of successfully managing your business’ accounting needs. Accounts receivable is only one part of the picture. If you’re still unsure on the basics of accounting, give our 21 small business accounting basics checklist a read. Or, if you’re totally savvy on accounting, go forth and prosper.

This article was produced by the QuickBooks Resource Center and syndicated by  

Featured Image Credit: iStock/monkeybusinessimages.