If having accounts receivables is part of your normal business operations, you need effective accounts receivables management, or AR management, to ensure credit sales don’t create a slow revenue stream. Whenever you make sales on account by extending credit to customers, instead of getting paid in cash right away, you record accounts receivables as claims held against customers and expect to collect the payments later. You can have better AR management by paying attention to both the amount of credit you grant to customers and the measures you put in place to deal with payment collections. The more credit you offer to customers, the less cash flow you can generate at the time of the sale, and any uncollectible accounts receivables becomes bad-debt expenses that you have to deduct from earlier-reported profits.
Credit Policy and Requirements
You can make sales on credit if that is the common business practice within your field of trade, but it doesn’t mean you have to extend credit to all customers unconditionally. You want a credit policy that spells out the credit requirements that customers must meet before you move ahead with credit sales. You shouldn’t extend the credit if you expect you might get stuck with uncollectible, delinquent invoices. You may make less sales, but you don’t have to spend valuable resources on nonrecoverable debt, which in the end doesn’t help improve your cash flow situation. Having a sound credit policy with clear credit requirements prevents you from accumulating too much unpaid accounts receivables while still making needed credit sales.
You might use discounts to manage sales and accounts receivables, including trade discounts and cash discounts. They are additional incentives, on top of the credit extension, for customers to make more purchases and prompter payments. You can offer customers a trade discount, or a certain percentage off a product’s listing or catalogue price, if they can make large quantities of purchases. Cash discounts are directly tied to AR management where you offer a cash discount off the invoice price as an inducement for customers to make prompt payments. For example, customers can take 2% off the invoice price if they can pay within 10 days of the sale when the normally scheduled payment on the credit sale is not due until after 30 days. Customers usually take such additional incentives because of the desirable returns implied from making a payment only days earlier.
Past Due Accounts
A past due account is not necessarily an uncollectible account. Customers in delinquency may have valid reasons such as severely limited cash flow. If that’s the case, you may try to negotiate new payment terms with customers, including accepting partial payments or payments in installments. You may also extend the current payment time and get customers off delinquent status if they can make a prompt deposit now and promise to honor the new deadline. All these measures can help preserve customer relationships without potentially losing future sales. In certain situations, even if you have to write off an account on your books, you should still make it as convenient as possible for the customer to pay later if it becomes possible. With credit sales, there is a dilemma between generating more revenue and maintaining sufficient cash flow. If you have AR management that addresses everything from setting credit policy and extending credit to creating payment incentives and collecting payments, you can minimize uncollectible accounts receivables and preserve cash flow while taking the chance to generate more revenue with credit sales.