One of the two ways a business can improve cash flow is by accelerating its collection of accounts receivable (or A/R). This approach works if your business sells to other businesses and extends trade credit.
A speedier collection of A/R will benefit your business by:
• Reducing the amount of necessary working capital tied up in A/R and converting it to cash;
• Lessening the overall risk of losses to your business due to customer insolvency;
• Demonstrating to your creditors and lenders that you use a “business best practice;”
• And “training” your customers to pay on time.
It isn’t necessary to use heavy-handed tactics to improve the collection of A/R. In fact a softer, more consistent, more persistent approach works best.
The best A/R collection practices first require you to know your days of A/R turnover -- this is the average number of days it takes to collect your company’s A/R. Some accounting software will give you an average outstanding number of days of A/R from invoice date. If your accounting program doesn’t give you this number, a good way to calculate your outstanding A/R turnover is by using the following formula:
A/R turnover (days) = total outstanding A/R / average daily sales*
*To get average daily sales, take the amount of sales your company had last month in extended credit and divide by 30.
For most industries, an average turnover is 45 days (assuming you give 30-day terms).
Below is a chart that shows how a company with an A/R balance of $150,000 generating $100,000 of new A/R each month looks when its days of turnover improve.
It may not be realistic to decrease your A/R turnover from 45 days to 30 days, but it could be realistic to reduce it from 45 days to 35 days over a period of several months. That would improve your cash flow by $33,333.
Here are a few proven ways to improve A/R collections:
• When you establish credit for new customers, make it very clear that while you expect to provide the highest quality of service possible, your terms are net 30.
• Have one member of your administrative team be responsible for making collection calls. Make sure they are polite and take the time to get to know your customers so that there can be clear communication when there’s a problem.
• Establish credit limits for all customers. When they hit their credit limit look to see if they have any past-due balances. Offer to ship when they pay the past-due balance.
• If you determine that a customer is a true collection problem, turn them over to a professional collection agency before the obligation gets too old. A good rule of thumb is 90 days if the customer isn’t buying new goods from you.
• Have your company’s owner or someone in senior management call the senior management of every customer quarterly to thank them for their business and especially for their prompt payment.
Staying on top of collections and A/R turnover must be an important goal of your management team. Everyone in an organization should realize that until the money is collected, the sale is not final. In addition, good A/R management shows both your customers and creditors that you follow this important best business practice.