Cash flow is critical to the success of your business. When cash is coming in, you can pay your operating expenses and reinvest in growing your business. When your cash flow is tied up in accounts receivable (AR), that cash is not available to spend. More businesses fail because of a lack of cash flow than a lack of sales, which is why staying on top of your AR is crucial. The longer it takes to collect on these accounts, the more likely it is that your business will fail. That’s why companies must be proactive in monitoring and collecting these debts.
Accounts receivable and cash flow
AR and cash flow are both components of the Cash Conversion Cycle (CCC), which is the measure of cash flow from creating and selling your product or service, expressed as a period of time. For example, if a distributor buys a product and sells it 30 days later, the CCC is 30 days. If the distributor sells on credit terms, the CCC is extended by the number of days stipulated in the invoicing terms. Cash flow, aka working capital, is the money that flows into your company through product sales and service and flows out in the form of paying expenses, paying down debt, and investing in growth. Cash flow is your company’s life blood. It lets you cover operating expenses, pay staff, purchase stock and grow your business.
One of the most important factors affecting cash flow is your AR. When customers pay down their AR, it increases your cash flow; whereas late or unpaid AR reduces your cash flow. It’s important to monitor your company’s cash flow to understand its financial health.
Managing AR ― reactive versus proactive
Reactive AR management versus proactive AR management can be likened to putting out fires as opposed to preventing them. When you put out a fire or send a collection letter, you will have more negative consequences than if you prevent the fire ― or overdue account ― in the first place. Proactive AR management is a strategy that helps you maintain positive cash flow as well as business relationships (e.g., sending a collection letter will likely cause resentment with customers and you may end up losing that customer). Changing from a reactive to proactive management style can play a big role in improving your company’s cash flow.
Becoming more proactive in AR management requires improving your billing practices and closely monitoring your AR status. Submitting all contracts in writing and using detailed invoices are just a couple of ways to improve your billing. Monitoring your AR will help you identify slow-paying accounts, because the earlier you begin collection efforts, the greater the chances of getting paid and increasing your cash flow ― which is the ultimate goal of proactive AR management.
Proactive AR management best practices
Some companies acquire a defeatist attitude about AR, and simply get frustrated when customers don’t pay on time. But successful companies make AR collections a top priority not just in the accounting department, but also throughout the entire company. To increase success, bring financial, sales, and management departments together to devise a strategy for optimizing AR collections. Also consider partnering with a financial services company that can guide your AR management.
Here are some best practices to get you started toward a more proactive AR strategy:
- Perform a thorough credit risk analysis to determine a potential customer’s credit worthiness.
- Have a written credit policy that outlines credit terms, including a set number of days before the account is overdue. (Shorter is better, i.e., 45 days instead of 60.)
- Create an AR aging report, which tracks the payment status of all your customers. This will help you identify slow-paying accounts before they become significantly overdue.
- Review your AR processes to identify bottlenecks in your debt collection system that require tweaking.
- Offer an early payment discount, and/or set up late payment fees.
- Use electronic invoicing instead of paper.
- Offer an electronic payment option to make it easier for customers to pay.
- Set up processes that automatically send reminders the first day accounts become overdue, rather than waiting 10 or 15 days.
The goal of proactive AR management is to increase your chances of collecting what is owed and to avoid sending the account to collections. Unfortunately, that doesn’t always happen, but you can improve your chances of collecting on past due accounts, in full or partially, by working with an experienced debt collection agency.