04 Apr Inefficiency in Accounts Payable and Receivable Affects Your Business
Cash flow is the lifeblood of a business. Inflows come from revenues, while outflows go to expenses. However, these are transacted initially from credit. Just like the blood pumping throughout the human body, businesses need to keep these two streams circulating ― or else the business will die. The trick is to find the right balance in managing these streams to optimize your cash flows.
Accounts receivable represent an extension of short-term credit to customers, which are usually due within 30 to 90 days. The significant factors when granting credit are the Four C’s: Character (willingness to pay), Capacity (ability to pay), Capital (financial sources such as collateral) and Conditions (economic status).
Inefficiencies could arise either if your credit standard is too stringent or too liberal. When standards are too lenient, they may eliminate the risk of non-collection and also alienate potential customers and sales. However, if your standard is too liberal, it may lead to higher sales, but it also runs the risk of higher bad debts/uncollectibles and other related collection costs.
Inefficiencies in your collection policies and procedures could lead to delays. Any delays can cost money and even your reputation, especially if you need the cash to pay your vendors and other expenses.
To improve cash flow, you need to accelerate cash collection and reduce negative float (the amount of time during which payments received remain uncollected due to processing time internally or within the financial system). You may do this by shortening credit terms, communicating with and invoicing customers promptly, offering discounts for early payments, and speeding up the time difference between your customer’s payment and your collection (for instance, using payment apps or fund transfers instead of checks).
How can you tell if you are efficient? Your accounts receivable turnover will give you the number of revenue-receivables-cash cycles you have completed for the year (net sales / average outstanding accounts receivable during the year). Your average collection period (days of the year/accounts receivable turnover) will tell you if are actually collecting within your credit terms. You can also create an aging report for you to analyze which accounts you need to focus your collection efforts on.
To further improve your efficiency, you can make use of technology such as QuickBooks Online, which allows you to send invoices to customers and accept payments via credit card or fund transfer. It also matches collections to open receivables and enables you to generate accounts receivable reports.
Accounts Payable usually refers to the amount due to vendors for purchases of materials or merchandise made on credit. Given that these are receivables from the vendors’ point of view, they are more inclined to shorten payment terms and impose penalties or interest for delayed payments. If you tarnish your reputation, vendors might refuse to grant credit moving forward.
It is best to cultivate strong business relationships with your vendors by paying on time. Establishing a good payment record might enable you to negotiate for more favorable or flexible credit terms or even discounts down the road. This gives you the opportunity to maximize your free cash flow and stretch payables by paying as late as possible but within the credit or discount period.
Inefficiencies may arise if you fail to record your payables accurately and timely, leading to delayed payments. Processing errors may also lead to duplicate payments or payments to the wrong vendors or with over or under amounts. These errors can hurt your cash flow. To help increase efficiency, you can use accounting software, such as QuickBooks Online, which also enables you to schedule payments and integrate with payment apps for seamless processing.