Monitoring Accounts Receivable: An Interwoven Process
by Rebecca Broady Treadway, CPA, MBA
So, what is all the hype about accounts receivable? It seems simple. Sales are made on credit, and customers make their payments within 30 days. Collection is what presents the knot at the end of the rope. Collection of accounts receivable is an increasing problem for small businesses. Cashflow is the lifeblood of a small company, and turning receivables into cash is crucial. Cash provides options and enhances financial flexibility. Cash is the means to an end; the means to remain competitive, the means to grow and the means to survive. Without sufficient cash, small companies drown in their own debt, losing credibility with suppliers and lenders, and ultimately forfeit the market position they worked so hard to acquire. Beyond the obvious financial impact, excessive receivables highlight and mask a number of conditions that affect the well being of the business. Collection actually begins with the sale; it is a process closely interwoven with company policy, customer relations, quality control and bookkeeping. Optimal receivables collection requires continuous monitoring in each of these areas.
Company policy provides the rubric for credit sales. Establishing a definitive company-wide credit policy provides uniformity and structure for a small business. Credit limits for individual sales and total credit outstanding must be established, and credit terms should be instated. If the company credit policy is not in writing, is not communicated and is not supported by top management, confusion results. Employees interpret policy drawing different lines of distinction and setting varying boundaries. Customers don't understand the inconsistency in policy application; they feel discriminated against and may complain, not pay, sue or take their business elsewhere. These negative repercussions only hamper productivity. Instituting a written policy that is upheld by upper management is instrumental for optimal collection. Employees need proper training and support to effectively carry out company policy.
Adhering to policy is vital. Often, management does not want to risk losing a customer or be perceived as hard-nosed or tight when it comes to cash; out of fear, company policy will be ignored. Yet, small businesses are ultimately more profitable when they are willing to uphold policy even if it means losing a few customers. A company shouldn't jeopardize its cash flow by granting credit to high-risk customers. Problem payers take much more than they provide. The business owner expends his or her energy and concentration on collection and neglects the core of the business. An applicant's credit history should be thoroughly researched using services such as Dunn and Bradstreet before issuance of credit. It may also be helpful to obtain credit references and follow up on what the client's vendors have to say about their customers credit history. Careful assessment of both the intent and the ability to pay is beneficial.
Know your customer. An important part of collections is knowing your customer: who your customer is, where your customer works and when your services are needed. By understanding your customer, you can tailor products and services to better accommodate his or her needs making for a happier customer, repeat business, good referrals and faster payment. Customer relations entail educating customers on products and services, communicating with customers on the availability of credit and explaining payment terms to customers. Ideally, customers should be made aware of payment incentives like the credit terms "3/10 net 30" (a three percent discount will be given if the amount is paid within 10 days). Small businesses may want to create more incentives to inspire payment. Management should make every effort to keep customers informed of policy changes, special promotions and annual sales events.
Active listening is imperative. A complacent, passive listener only complicates collection issues, whereas an unselfish, empathetic company representative promotes and repairs customer relations. When an account is overdue, it becomes even more important to hear the customer and understand the reasons behind nonpayment. A small business must think in terms of meeting the customer more than halfway; what about partial payment or an extended payment period? Breaking the bill into smaller payment increments might be the right choice. Collecting something is better than nothing at all. These options seem especially appropriate for clients in good standing that are unable to pay due to an unexpected crisis.
Billing is necessary. Billing represents a fundamental component of healthy customer relations; it serves as a reminder to the customer of his or her responsibility and obligation. Mailing invoices on a timely basis promotes quicker payment. Customers should be billed at least once a month for their purchases. Bimonthly billing encourages even faster payment. A detailed billing statement presented in a simple format provides the customer with key information that can be easily understood. Include the following, if applicable, on a billing statement: product purchased, quantity, color, description, date order received, date order completed, billing date, billing rate, time spent on the job, job specifications, prior balance, prior payments and amount due. An enclosed envelope is customer friendly and prompts return payment.
Product and Service Quality
Product and service quality directly affects the collection process. If the customer is dissatisfied with a product or service, he or she will often delay payment or simply won't pay at all. A damaged product or an incomplete job only frustrates the customer. To speed up collections and avoid this pitfall, small businesses must ask themselves some evaluative questions. Does the product or service sold to the customer have the same standards that the company advertised the product or service to have? Does the product perform to specifications? Is the service complete? A negative response to these questions implies that quality of the product and service may well interfere with collection; it is a definite sign that management should look into quality control. Customer feedback is increasingly important in today's competitive market. Small businesses may want to incorporate customer surveys or response cards into the collection process. The return and exchange processes likewise should be handled efficiently without long delays and with the utmost respect for the customer at hand.
Small businesses must monitor individual accounts receivable balances on a customer by customer basis. Posting customer payments to the proper account in a timely manner helps ensure that records are accurate and reduces misunderstandings. A monthly aging of accounts should be performed to provide an overall picture of receivables. Individual accounts are categorized as the following: more than 30 days past due, more than 60 days past due, more than 90 days past due and more than 120 days past. Ideally, management will collect receivables before the accounts enter the more than 60 days due category. If the majority of receivables reside in the 90-day or later categories, management may have some serious collection problems. The average time that an account is overdue informs management whether enough precautions are being implemented to alleviate late payments. Management can easily infer from the average time that an account is overdue when to expect cash inflow from collections. Yearlong records can be used to identify seasonal cash-flow crunches.
Keep collections personal. Collection procedures for small businesses are best performed in-house. Outsourcing collections is expensive and somewhat impersonal. By directly servicing the client, small business owners gain more client contact, and customers feel included and known. Customers are more likely to respond to an entity they recognize than to a generic collection service. Management likewise gains insight on the strengths and weaknesses of its own operations. A worthy investment to enhance the collection process is incorporating sound internal controls throughout the collection process. Incorporating proper segregation of duties, limited access to records and strong hiring and training programs are beneficial.
"The object of accounts receivable management is to collect all revenue as quickly as possible with a minimum of special effort of company personnel, a minimum of disputes with customers, a minimum of returns and allowances and a minimum of bad debt or other losses? (Colby, 1996, p.36). Keeping these items at a minimum will enable small business managers to maximize return. Better collection provides more predictable cash flow. Bank borrowings can be reduced minimizing interest expense. The availability of credit allows small businesses to remain competitive giving customers a choice of how to pay. Collections work best when they are part of an interwoven plan, when there is a consistent, conscious effort to remain customer-oriented. Stay focused on receivables; it is well worth the effort. It pays off sooner rather than later.
About the Author
Rebecca Broady Treadway, CPA, MBA., is an assistant professor of accounting at Maryville College.
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