Managing your accounts receivable to generate prompt payment is an effective way to conserve cash. In retail trade, payments generally are made immediately (in cash) or with a slight delay (debit or credit card or check). Once you are in a business that extends credit terms to its customers, you will need to manage the timing of payments. The sooner you collect on receivables the better, from a cash flow perspective.
The Cash Effects of Accounts Receivable
Receivables affect cash availability. If you are not actively billing and collecting the monies owed, you can rapidly find yourself with too little cash to operate your business. You will be, in effect, lending your precious cash to your customers while they have the use of the products or services they bought.
The Life Cycle of Accounts Receivable
An accounts receivable has a life cycle, which will vary according to your type of business. For most retail businesses, there is no extension of credit and receivables effectively do not exist. Wholesale and manufacturing companies routinely have receivables that depend on their credit policies and collection efforts. One tool that companies employ to manage their receivables is an “aging schedule” for accounts receivable.
By creating and updating an aging schedule on a routine basis, you can keep track of your collections and anticipate your cash flow. You can easily identify problem customers and attempt to work with them to improve payment promptness. Also, making use of aging information can help to establish a forecast of cash flow.
Of course, aging reports are only part of the cash-flow management process. Timely billing and effective collection are critical. If you are extending credit to your customers, a fundamental rule is: If you don’t ask, you won’t get. You have to invoice promptly and collect regularly. Whereas this may seem obvious, one of the most common cash-flow issues for companies is their failure to bill and collect effectively.
One challenge that entrepreneurs face is segregating the collection process from sales and customer relations. A legitimate concern is the potential for losing a customer by asking for—or demanding—payment for previous purchases. A failure to collect on a timely basis can lead to financial disaster for an entrepreneurial venture. Overly aggressive collection attempts, however, can also lead to calamity, through the loss of key customers. Keeping these guidelines in mind will help to maintain a balance:
- Establish clear credit arrangements with customers that reflect acceptable terms for both of you.
- Create comprehensive written credit and collection policies, share them with your team, and implement them.
- Use collection techniques appropriate to the level of delinquency.
- Avoid using salespeople as collectors on their assigned accounts.
- Comply with the Fair Debt Collection Practices Act and do not use intimidation or deception in collections.
- Recognize that some customers are worth “firing” as credit clientele.
The Financing of Accounts Receivable
Accounts receivable can provide a ready source of cash for your company if you are in a bind. Receivables financing, or factoring, provides cash to companies in exchange for the rights to the cash that will be collected from their customers. Fn you factor your receivables, you provide a list of the outstanding amounts and their status in an aging chart to the finance company, and they will offer you a percentage of each category of receivable in exchange for the right to those proceeds when collected. Fresh accounts are worth significantly more than older ones.
Sometimes, you can be charged for accounts that do not pay within a specified length of time. Factoring is common in some industries and highly unusual in others. You will need to understand your industry to determine the applicability. The key thing to remember is that you will forgo the opportunity to control the collection process and give up potential profits in exchange for immediate cash. As a general rule, factoring is not the ideal option because it can become the proverbial slippery slope. Learn more about how to manage receivables at LSBF.