Accounts receivable is a term used to describe the quantity of cash, goods, or services owed to a business by its clients and customers. The manner in which the collection of outstanding bills is handled, especially in a small business, can be a pivotal factor in determining a company's profitability. Getting the sale is the first step of the cash flow process, but all the sales in the world are of little use if monetary compensation is not forthcoming. Moreover, when a business has trouble collecting what it is owed, it also often has trouble paying off the bills (accounts payable) it owes to others.
By extending credit to a client—selling on payment terms other than cash up front—you are, in essence, lending them money. Collecting this money is of critical importance to the health of a company. Nonetheless, many small business owners depend primarily on the good will of their clients as a collection policy. They simply send out an invoice and them wait, and wait. A collection policy designed to minimize payment delays is a good idea for companies of any size.
In an ideal world, a company's accounts receivable collections would coincide with the firm's accounts payable schedule. In the real world, there are many outside factors working against timely payments some of which are well beyond the control of even the most vigilant manager. Seasonal demands, vendor shortages, stock market fluctuations, and other economic factors can all contribute to a client's inability to pay bills in a timely fashion. Recognizing those factors and incorporating them into the cash flow contingency plan can make a big difference in establishing a solid accounts receivable system for your business.
By looking at receipts from past billing cycles, it is often possible to detect recurring cash flow problems with some clients, and to plan accordingly. Small business owners need to examine clients on a case-by-case basis, of course. In some instances, the debtor company may simply have an inattentive sales force or accounts payable department that needs repeated prodding to make its payment obligations. But in other cases, the debtor company may simply need a little more time to make good on its financial obligations. In many instances, it is in the best interests of the creditor company to cut such establishments a little slack. After all, a business that is owed money by a company that files for bankruptcy protection is likely to see very little of what it is owed. However, a business that has determined that its late paying customer is well managed may decide by giving that customer a little more time and by doing so, perhaps a chance to grow and prosper becoming a valued long-term client.
Methods of Collecting
A good way to improve cash flow is to make the entire company aware of the importance of accounts receivable, and to make collections a top priority. Invoice statements for each outstanding account should be reviewed on a regular basis, and a weekly schedule of collection goals should be established. Other tips in the realm of accounts receivable collection include:
- Get credit references for new clients, and check them out thoroughly before agreeing to extend the client credit
- Do not delay in making follow-up calls, especially with clients who have a history of paying late
- Curb late payment excuses by including a prepaid payment envelope with each invoice
- Know when to let go of a bad account; if a debt has been on the books for so long that the cost of pursuing payment is proving exorbitant, it may be time to consider giving up and moving on (the wisdom of this depends a lot on the amount owed, of course)
- Collection agencies should only be used as a last resort
The longer it takes to collect on an invoice, the less likely collection of the money becomes. As a rule of thumb, according to Dr. Cornwall, Director of the Belmont University, Center for Entrepreneurship, "never let any one customer represent a larger percentage of your total sales than your average profit margin. That way if you need to fire a customer, you can still pay your bills."
ACCOUNTS RECEIVABLE FINANCING
Accounts receivable financing provides cash funding on the strength of a company's outstanding invoices. Instead of buying accounts, lenders use invoices as collateral against which they extend short-term loans. Besides benefiting a business in debt, accounts receivable financiers can assume greater risks than traditional lenders, and will also lend to new and vibrant businesses that demonstrate real potential. An accounts receivable lender will also handle other aspects of the account, including collections and deposits, freeing the company to focus on other areas of productivity. However, risks are involved in this sort of undertaking and agreements are typically lengthy and steeped in legal lingo. Before considering this type of financing it is recommended that an expert assessment of the specific collection situation be sought.
Bannister, Anthony Bookkeeping and Accounts for Small Business. Straightforward Company Ltd, April 1, 2004.
Bragg, Steven M. Accounting Best Practices. John Wiley, 1999.
"Collecting Yourself." Inc. March 2000.
Cornwall, Dr. Jeffrey R., David Vang, and Jean Hartman. Entrepreneurial Financial Management. Prentice Hall, May 13, 2003.
Flecker, Cody. Collect Your Money: A Guide to Collecting Outstanding Accounts Receivable. Cobra, 1998.
Longenecker, Justin G., Carlos W. Moore, J. William Petty, and Leslie E. Palich. Small Business Management. Thomson South-Western, January 1, 2005.
Schechter, Karen S. "Compare Costs, Benefits of Billing Service Vs. In-house." American Medical News. July 24, 2000.
Schmidt, David. "Agents of Change." Business Credit. October 2000.