Managing accounts receivable
Understanding your accounts receivable and cash flow can help keep your business profitable, and help determine which customers are worthy of a credit extension.
We often hear that cash is king. Cash gives us the ability to pay our bills when they are due and purchase needed business inputs in a timely manner. The collection of money from our sales is what business is all about. The longer it taakes a customer to pay us, the longer it will take for our business to pay our bills or pay off our operating loan.
Remember that our payables (i.e. supplies we purchase on credit) are our supplier’s accounts receivables. We may seek discounts from suppliers when we pay cash. Customers may seek similar cash discounts when they prepay or buy with cash. For many businesses, an operating loan keeps payables to a minimum. Therefore, as sellers, if we encourage our customers to obtain their own operating loan, we reduce our risk with receivables and bad debts.
Two key tools are the receivable turnover ratio and the average collection period.
receivable turnover = net of credit sales / average net receivables
This ratio indicates the average number of times receivables turn (are collected) during the year. The average collection period can be converted into days by dividing the receivable turnover ratio into 365 days.
average collection period = 365 Days / receivable turnover ratio)
For many operations, caution and control measures should be implemented if this number is greater than 40 days.
Many accounting systems can help track receivables. Effective managers utilize the accounts receivable aging report. The report list accounts 0-30 days, 30-60 days, 60-90 days, and accounts over 90 days. The aging report allows you to identify slow-paying customers, follow up on collections, and evaluate credit and collection policies.
Remember that you are a lender of money when your customers buy on credit. You should use the same criteria as your lender uses with you to determine your credit worthiness.
Consider these factors as you determine which customers get credit and how much. Using clear, well-defined terms, can reduce the amount of staff and management time dedicated to collection problems. We may not be able to eliminate all bad debts (collectibles); but we can greatly reduce our risk with sound management tools.