Starting and running a business has more to it than operations. In business, you give credit to customers or accept payments later. This leads to accounts receivables (AR). Account receivable is the ugly duckling, the elephant in the room that no one wants to address. However, accounts receivables can pile up when left unaddressed, leaving business owners tight on cash and borrowing money. Taking on debt adds to finance costs, thereby reducing your profit.

The Cost of Weak Accounts Receivable Practices  

What leads to weak accounts receivables practices? First, companies often go overboard with credit, leading to credit risks and defaults. Other times it is a system issue like an invoice error, poor follow-up, or the incorrect allocation of a cash payment. You can avoid all this by adopting a systematic and methodological approach to managing accounts receivables.

Timely conversion of accounts receivable into cash can help you improve operational efficiency and reduce debt, fund growth, lower costs, and tap the right opportunities. This article discusses five effective ways of converting AR into cash. 

Dictate Payment Terms at an Early Stage 

Some companies tend to go overboard with sales. The pressure to meet sales targets encourages salespeople to offer too much credit or leave payment terms unclear. All this slows AR conversion to cash.

You can set a customer credit policy. Or you can set a process where the sales and finance team together dictate competitive payment and credit terms agreeable to both parties. But ensure the process is not lengthy or time-consuming, or you might miss the golden window of opportunity to close the sale. 

In case of a big order, you might even ask for an advance or milestone-driven payment where you get paid as and when you achieve a predetermined target. 

Prepare a Master Data of Customer Details 

Many small businesses handle accounts receivables themselves, and an invoice is a perfect place to make mistakes. For example, an invoice could have errors in customer details, typos, data entry errors, calculation mistakes, and inaccuracies in credit terms offered to customers. You can resolve this issue by creating master data accessible to all key team members and the management involved in the invoicing. 

This master data can include customer contact details, volumes, discounts, and other credit terms. You can also flag any history of delayed or failed payments with a customer and revise your credit policy with a particular client.    

Keep auditing and updating the master sheet from time to time to avoid any anomalies in the sheet or the invoices that populate the data from the sheet. With all the data in one place, you can also analyze how your credit terms with customers will impact the days of sales outstanding (DSO) and future cash flows. 

Set an Invoicing Process 

Once you have created the accurate invoice, it is time to send it to customers, ensure they received it, and follow up with them. Unfortunately, many small businesses still use paper invoicing, which is time-consuming, difficult to share, track, and easily misplaced. Lost paperwork means late or missed payments. 

An effective way is to use technology to automate your invoicing process. If you don’t want to use software, prepare digital invoices that are easy to find, share and download. If you offer special rebates, extra deliverables or any other exception to a client, you can prepare some exception reports. 

Making an invoice is just the first step. Set up a process to send out invoices on a particular day. Also, set a day to check on updates and follow-up with clients in the case of non-payment. You can seek an expert’s help to set up an invoicing system and audit it quarterly or half-yearly to optimize it. (Optimizing a process removes unnecessary steps and fills gaps with new measures). 

Set a Process or Proper Allocation of Cash Payments 

One part of invoicing is the follow-up; another area that is prone to mistakes. Most companies credit the payment to the client’s account without allocating it to the respective invoice. This can create issues during invoicing and follow-up. 

For instance, Amy has three invoices pending with three different teams of ABC company. 

Invoice No.ABX01ABY03ABZ02
Date due1-Apr-211-Jun-211-May-21

ABC paid $15,000 against the ABY03 invoice dated June 2021, but Amy wrongly allocated the payment to ABZ02 dated May 2021 and marked that invoice paid. She follows up with the Y department on the June invoice. But in ABC’s record, the June invoice status is settled. Clearing this confusion will consume time and delay other payments as Amy did not follow up with the correct department. This example is only one layer of complexity. In reality, there are additional layers like mode and terms of payment. 

A good practice is to update your accounts as soon as you receive the payment to ensure the payment is allocated to the right client and the correct invoice. Also, ensure you include details like mode of payment and transaction number in your records. 

Devise a Method to Collect Payments 

You have set up an invoicing process and followed up with the client, but there is a late payment. In addition, the client may sometimes avoid your calls, probably because the client’s business is not doing well. How would you collect payments without damaging your business relations in such a scenario?  

Firstly remain calm and adopt a methodological approach. Try to understand why the client is defaulting. There could be genuine reasons like the client might not have enough money. Here you can renegotiate payment terms (extend the duration, installment-based payment) offer some discounts. Even after negotiations, if there are no payments, you may indicate the consequences of poor credit rating in the market. 

The last resort is knocking on a courtroom door. But don’t take this route unless the payment is worth it, as legal assistance is not cheap. It might be better to write off your accounts receivables if it’s a small payment. But ensure your credit risk is in check. If a large portion of your AR goes into bad debts, it could harm your cash flow. 

All is Well that Ends Well 

AR can bring you more business, but it comes with credit risk. The trick is to optimize your AR and improve the cash flow conversion.

Call Glenn Graydon Wright LLP in Oakville for Trusted Business Advisory and Accounting Advice

Let the financial professionals at Glenn Graydon Wright LLP help you set up a well-functioning AR department and improve your cash flow conversion. At Glenn Graydon Wright LLP, our highly-skilled accountants provide expert accounting, business advisory, and tax solutions to help clients achieve their financial goals. To learn more about how we can help your business, contact us online or telephone at 905-845-6633.