One of the most critical components to keep a company in positive cash flow is accounts receivable management. Every day that passes, there is a cost to uncollected receivables. We’re focusing on techniques for faster collection to reduce costs and increase cash. Later we’ll discuss the credit decision and bad debt reduction, however, we’ll assume you’ve already made the decision to grant credit and just want to collect faster.
THE COST OF RECEIVABLES OR “WHY COLLECT FASTER?”
Every company’s cost of receivables is different. For example, a company with $7 million annual sales volume putting all their excess cash in a 4% savings account daily loses $767 annually for each day of collection time. If instead of a savings account, that same company needed the cash to build a project with an expected rate of return of 10%, the cost increases to $1,917.
The key is “what could your company be earning with that cash if it was collected?”
If you wish to calculate your own actual cost of receivables, perform the following steps:
1. Compute your average collection time.
A. Total accounts receivable at month-end $__________.
B. Year to date sales $______
C. Days to date in your fiscal year _____. (For example, a 2/29 statement on a 12/31 fiscal year end equals 60 days)
D. Average collection time = (A x C) divided by B.
(____ X ____) / _____
2. Now compute your cost.
E. Average collection time from (D) above
F. One day’s sales (YTD sales divided by C)
G. Investment opportunity rate for your company.
H. Cost = E x F x G
Cost = ____ X ____ X ____
For clarification, let’s look at an example. Sample Distributor has $500,000 in accounts receivable at February 29th. His annual sales volume is $7,000,000 and his year to date sales are $1,167,000.
Average collection time =
$500,000 x 60 days = 26 days $1,167,000
Cost of receivables =
19,450 ($7Million /60) x 4% x 26 days = $20,228
Thus, this owner loses $20,228 in lost money market savings interest each year. Now granted, he can’t just get rid of his receivables, but, he can speed them up!
EASIER SAID THAN DONE OR “HOW DO I SPEED UP COLLECTIONS?”
There are several rather painless ways to speed up collections:
1. Invoicing Frequency– The faster you invoice, the faster you collect! Your customers should be paying off of invoice, not waiting for a billing statement. So what frequency of invoice is best? Point of sale invoicing. Even if you are invoicing daily but waiting for drivers to return from the field and then generating an invoice, you’re losing at least two days of collection time between processing and mail delays. The costliest system is monthly invoicing which seems to be the case in many rural areas.
If you’re not on a point of sale invoice, try speeding up just one notch from your present cycle. For instance, if you’re on monthly, try going to bimonthly; on bimonthly, try weekly; on weekly, try daily; on daily, try point of sale. The largest fear with implementing point of sale invoice appears to be driver/deliverer error. But correcting a few mistotalled invoices back at the home office is much more efficient than delaying every invoice for perfect totals!
2. Statement Frequency – The most common billing statement frequency is monthly but bimonthly statements will speed collections. Lost invoices are caught and paid more rapidly on a bimonthly system. Most customers will not tolerate a weekly statement but look at that possibility for selected accounts with high numbers of deliveries each week.
3. Terms – Shorter terms speed collections. If you’re at net 30, would net 25 work in your marketplace? Competition often drives terms but prompt, quality service can often mean toleration of a slight difference in terms. Five day’s faster collection time can mean substantial savings! Look at your terms. Can you change your terms by one day or more without disrupting your competitive position?
4. Late Pay Finance Charges – Terms are great but what’s the consequence to your customers for late pay? If no consequences, there’s no incentive to pay on time! With typical late finance charges at 18% and bank borrowings at well under 10%, there is incentive for your customers to pay to terms and good compensation for your company from those who don’t pay promptly.
5. Avoid giving prompt pay discounts – Unless you’re really in a cash crunch, even 1% prompt pay discounts to your customers cost you more than carrying the receivable to full term. We won’t walk through the math now but feel free to call the Meridian office if you would like a calculation.
6. Telephone follow-up – Probably the most effective yet least used method to speed receivables! Assign one office staff person to run daily receivable listings or manually track all due accounts and payments. Call all customers who are two or more days past due. The noisy wheel gets the grease and the polite but firm collections clerk gets the check. This friendly phone call can also reduce bad debt by catching a problem account early. When calling, make sure that the receivable listing is noted appropriately when a customer promises to pay by a certain date. A tickler system is necessary because if payment is not received, you must call again! I know of one distributor who lost 5 days in his average collection time when his receivables clerk went on a two-week vacation. Proof that it really was working!
In conclusion, SLOW RECEIVABLES COST YOU MONEY! By careful attention to billing process, customer terms, late pay charges, and telephone follow-up, you can significantly increase your bottom line profit.
