05 Apr 12 Best Ways to Manage Accounts Receivable
The critical event in a business’ normal operating cycle is the sale of goods and services. However, there is a need to sell on credit to attract more customers and earn more revenue, leading to the recording of Accounts Receivable. Upon collection, the cash is re-invested into the business, and the operating cycle begins again. If collections are low or delayed, then the business might run into cash flow problems, affecting its ability to operate on a day-to-day basis and settle its liabilities when they are due. This might prompt the business to source additional funding through borrowings, or worse, shut down and declare bankruptcy.
All those repercussions highlight the importance of effective management of Accounts Receivable to the cash flows and operations of any business.
Proper management involves formulating and administering policies related to sales made on account and ensuring that receivables are maintained at an acceptable level and that they are collectible as planned.
So how to manage accounts receivable?
Below are some ways to manage Accounts Receivable more effectively:
Determine how much you can afford to extend on credit and for how long
Check your working capital requirements and determine the optimal levels of cash that you need to break even (at least), as well as the timing of when you need the cash. Ideally, you accelerate the timing of your collections and slow down or control the timing of your disbursements. The Days Sales Outstanding (DSO) or average collection period [(Accounts Receivable / Net Sales) x 365] is a measure of how long it takes for you to collect your receivables. A high DSO means that the business is taking longer to collect and may indicate potential cash flow problems.
Set payment terms
You can check the usual payment terms in your industry for comparison ― commonly it’s at net 30 days. If you are just starting out, perhaps you can start with a conservative period (15 days if possible), and then extend if a customer eventually requests so and proves to be credit-worthy. You need to ensure the clear payment terms are indicated in your invoices or service agreements.
As an incentive, you can offer cash discounts for early payments. As a deterrent, you can consider imposing interest/penalties for delayed payments to show customers that you are serious about getting paid. You can also include a “dead beat clause” in your contracts, stipulating that customers will bear the legal fees should you be forced to sue for non-payment.
Create a criteria for the evaluation potential credit customers
Doing a credit check prior to extending a line of credit to your customers will save you a lot of headache and minimize your credit risk down the road. The objective is to strike a balance between getting more credit sales and shouldering the costs and risks of maintaining Accounts Receivable.
If your credit standards are too tight, then you may eliminate the risk of non-collection and also risk rejecting the potential sales to customers who didn’t qualify. If your credit standards are too loose, then you may generate higher sales but also have higher risk of non-collection due to bad debts and potentially incur higher collection costs.
Set a clear list of requirements for applicants (e.g.,application form, references, financials, etc.) so it would be easier for you to look into a customer’s 4 Cs: character or (willingness to pay), capacity (ability to pay), capital (financial sources) and conditions (current economic or business conditions).
Formalize your credit and collection policy and ensure compliance
Document your credit and collection policy and ensure that only people with properly delegated authority are allowed to approve the extension of credit (or exceptions, if any), resolution of disputes, and assessment of bad debts or write-offs. You must include procedures for collecting delinquent accounts to ensure that the entire collection cycle is covered.
Send out your invoices promptly
The faster you send out your invoices will also lead to the the faster turnaround of your clients to prepare for the due date — and faster you can get paid! You have to state clearly that it is an invoice (as opposed to a statement) and indicate the actual due date. Consider sending electronic invoices to make the process more efficient.
Provide payment options to customers
The objective is to speed up collection. Providing customers with various options such as credit cards, online payments or fund transfers, will make it more convenient for them to pay and will also reduce the time spent waiting for payments to arrive. Those payment options are more convenient and faster compared to checks which still have to be mailed and cleared through the banking system.
Record collections promptly
Apply the cash collections to the open receivables in a timely manner so you would have accurate financial records, and you could detect any errors or discrepancies immediately.
Proactively monitor you receivables weekly
Create an aging report of your receivables, showing the customers and amounts in age “buckets” such as “Current,” “1-30 Days Overdue,””31-60 Days Overdue” and so on. This will enable you to track those that are about to be due, make friendly “gentle reminders” to customers, and more importantly, focus your collection efforts on those that are overdue. If an account is overdue, contact the customer directly and find out what the problem is so you could decide on your next course of action.
Using accounting software could make managing Accounts Receivable more efficient. For example, QuickBooks Online allows you to create and send out electronic invoices to customers with the option for them to pay online for seamless billing. The system also matches the payment received to the open invoice for prompt recording. It also allows you to track due dates and generate Aging reports for your convenience.
Consider hiring additional help
If problems arise in collecting from overdue or delinquent customers, it is best to handle the resolution in-house. If this is taking too much time from other aspects of the business operations, then consider hiring an Accounts Receivable Manager or outsourcing a collection agency as a last resort. However, you need to weigh the corresponding costs.
Know when to cut your losses
Stop extending credit to customers who are late on paying their bills. This only reinforces their delinquent behavior and increases the risk for your business.
Consider receivable financing
If your business is really strapped for cash and can’t wait for the completion of the normal cycle, you can use your receivables as a source of cash through receivable financing. In factoring (with recourse), you assign your receivables to a “factor” who gives you money up front equivalent to a certain percentage of your receivables value, then typically assumes credit and collection responsibilities. Once the invoices are paid, the factor will pay you the remaining balance less a host of fees and charges.
Selling on credit can make your business more attractive to customers, but it has risks. Make sure to take into account the financial health of your business and remember above tips on how to manage accounts receivable.