Take a minute to look at your most recent balance sheet. If you are like most family business owners, the largest single asset you’ll find on your balance sheet is your accounts receivable. That’s your cash, sitting out there waiting to be collected.
In light of the fact that receivables are your company’s largest asset, do you know:
How long on average is it taking you to collect your accounts?
How many customers are past due?
What the potential is for bad debt in those receivables?
If you don’t readily know the answers to these three questions, you should. Slow receivables force you either to borrow money from your bank (costing interest) or to lose the interest you would have received had you had this money in your savings.
Consider that for every extra $100,000 in slow receivables, the average family business is forced to pay an extra $10,000 in interest expense to the bank!
Collection Time – To determine how quickly (or slowly) on average you collect from your customers, perform a simple calculation called Average Days Sales Outstanding.
With your most recent profit-and-loss statement in hand, look at last month’s sales dollars. Divide the sales dollar amount for the month by the number of days in the month. (30 or 31, unless the statement is for February). The result is your company’s average daily sales.
Next, divide your total accounts receivable balance by your average daily sales. This final calculation will tell you how many days on average it is taking you to collect your accounts receivable.
With knowledge of your collection time, you can determine:
- how your company is doing compared with your own selling terms
- how your company compares with the industry; and
- any trends in payment time.
Look at receivables days compared to selling terms. Receivables days should approximate selling terms within a few days.
Your final analysis will be to check the trend in your accounts receivable days. What was your collection time for the past three months. Is the collection time going up (a bad sign), staying stable, or going down (a good sign).
To speed up your receivables, do the following:
Only sell to creditworthy customers – If a potential customer is known to pay slowly, he may be too costly to serve. Let your competition have the headaches and expense of this account.
Establish the expectation for prompt payment at the time of first sale – Have sales staff let new customers know that you expect payment when due.
Review selling terms – Shortening terms will speed up collection time. (Don’t offer costly discounts, however, to encourage prompt payment.)
Check invoicing procedures – Are your customers receiving bills promptly? If your invoice goes out late, your payment will likely be late, too. Make sure customers are being billed same or next day or at a specific time each month. Some family businesses find dropping an invoice at the time of the delivery or when the service is provided is the best way to facilitate payment.
Use late penalties – If there is no consequence for late payments, why should customers pay on time? Establish and enforce late fees.
Call delinquent accounts – Let your customers know you expect prompt payment by phoning when they are a few days late. This lets them know nicely that you expect prompt payment.
Use price increases – When one of your chronically late customers calls for prices, let them know that because of their late payment history, you must increase their price. They’ll get the message.
Withhold product – Let seriously late accounts know you will reduce or cut off delivery entirely or will not provide service to them at all. Should they pay off the account, require payment in full before providing any services going forward. If a customer can not make even a partial payment, be prepared to stop serving that account immediately.
Past Due Customers – Management and all salespeople should know which customers are past due. Have your credit department prepare a weekly list of your past due accounts.
Potential Bad Debts – First, the credit department should identify high risk accounts. Next, take steps to take collateral to secure their indebtedness. Develop an active plan to recover these amounts.
