All companies go out of business for the exact same reason: They run out of cash. And one of the biggest factors that can impact how much cash flow a business has is how well they manage their 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 from the client 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 position is actually 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. This happens mostly via a credit-card or online payment.
Remember, however, that credit is a privilege and should not be given to all clients. This is especially true for people that have never done business with the company before. If a new client will not buy from a company because they can’t get credit, maybe that is a sale that should not get 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.
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.)
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.
- 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 15 days if possible, and extend them if asked by the customer over time. State a specific date that the payment is due, not “upon receipt” because the customer then has the tendency to set their own date.
- 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.
3. Track Payments Carefully
Most clients want to pay their bills on time. They just need a little help to pay within terms.
To encourage timely payments, proactively call soon after the invoice is sent out to make sure they received it and to ask when it will be paid. 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.
5. Cut Off Credit to Overdue Clients
Information about overdue clients can be found on an accounts-aging report from QuickBooks. Too many small business owners continue to extend credit to customers who are late on paying their bills. 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; check out our tutorial on invoices to make sure yours get paid on time and in full.