While many sales managers measure their success on the amount of sales they make, companies don’t actually make any money until they have it in their hand. Until then, they could be in financial trouble. On the surface, it might seem like your business is on the right track when revenues exceed expenses. But in reality, businesses thrive when the cash they receive exceeds liabilities and expenses paid. That revenue has to convert to cash on hand. Since businesses often fail when they run out of cash, and since some sales cycles make it difficult to boost sales at certain points during the year, it is imperative for your company to tighten up its accounts receivable practices to sustain a position of financial stability even during times when sales are sluggish.
There Are Many Reasons Why Tightening Up Your A/R Practices Can Help
- Reduced risk for write-offs.
- Reduced risk of commission charge-backs.
- Improved liquidity. If you’re not a bank, then don’t act like one. Keeping liquidity strong helps your credit line balance. That frees up cash for new purchases.
- Better operational procedures. If all customer information is available in your distribution management software system, all employees can access accounts, solve problems, be alerted to credit holds, and view customer status instantaneously.
Developing strategies for tightening up accounts receivable is in order. Here are some strategies you might want to consider.
Evaluate Your Accounts Receivable Policy
Sometimes the problem lies with the structure of your accounts receivable policy. When reviewing your current company policy, consider:
- Requiring larger down payments. This can help you increase working capital.
- Reducing your terms. For instance, if you offer 90 days, lower it to 60 days; or if it’s 60 days, lower it to 30 days. Did you know that there is an inverse relationship between the age of your receivables and the likelihood of you collecting on them? Statistically speaking, the sooner you collect, the less likely your customers will be to delay payment or request discounts.
- Tightening credit requirements. One of the biggest questions to ask is, “Who gets credit?” Tell customers about your credit requirements up front and require a personal guarantee. Don’t be afraid to deny credit.
Being consistent in how you apply your policy. Notify customers of the terms before the sale, extend credit only to those who meet your requirements, and ensure invoices are sent in a timely manner and contain accurate billing information. They may leave for other reasons, but customers generally don’t leave because your require payment according to your stated agreement.
Tightening up your accounts receivable policy can increase the amount of money you collect from your customers.
Check Out Your Collection Effectiveness Index
Companies frequently use days sales outstanding (DSO) – how many days it takes to collect a payment after a sale – to determine how efficient they are at collecting outstanding accounts receivables. The lower the number, the better the turnaround, and the greater chance that company will be successful.
The formula for DSO is:
However, another suggestion is to use the collection effectiveness index (CEI). According to the Credit Management Association (CMA), the CEI is a percentage that…
…expresses the effectiveness of collection efforts over time. An index closer to 100 percent, indicates a more effective collection effort. Remember, it is a measure of the quality of collection of receivables, not of time.
Focus on Closing Overdue Accounts
The longer an account stays open, the longer you have to worry about it. Instead, consider closing all accounts that are 60 days past due.
Additionally, involve your sales staff. Sales teams have special relationships with your customers and rely on their sales to make a living. Therefore, they are motivated to collect payments. Otherwise, don’t pay commissions on outside sales that are unpaid after 90 days.
Finally, consider updating your accounts receivable management software. An ineffective system can slow the process and fail to provide the information you need to improve your cash flow. Using a manual billing process can mean dealing with challenges such as extra handling costs and errors in manual data entry.