Even with steady sales and growth, if your company has continual cash flow issues due to lack of accounts receivable management, that could slow or stop your company's growth.
Nearly one-third of businesses find that they are unable to pay vendors, unable to make loan payments or unable to pay themselves or their employees, according to a report by Quickbooks.
The report also highlighted that more than a quarter of entrepreneurs had to turn down a sale or opportunity due to insufficient cash flow.
“There are many different things that go into running a successful business, but cash flow is what keeps it running," said Aaron Dyer, a business banking regional manager at City National Bank.
Having ample cash flow allows you to continue expanding, whether you want to buy your company's building as a way to generate another stream of income instead of renting or you want to upgrade your company's technology and need cash to lease equipment.
Small businesses that manage their accounts receivable effectively have a formalized process for collecting accounts receivable as well as strategies for spotting potential cash flow issues and addressing them before they become detrimental to the business.
The first step to take control of your collections efforts is to determine the current payment status of all your accounts receivable.
This is done by creating an accounts receivable (A/R) aging report, which will track and measure the payment status of all your customers.
Accounts are broken out by the number of days since the invoice was issued, such as:
The report also lists the amounts due. If this report is updated and reviewed on a regular basis, it can help to address any potential problems before the bill becomes past due.
“The financials and accounts receivable aging report are an important piece of weekly management for the business," said Dyer.
Another helpful tool is a calculation of your company's Accounts Receivable Turnover (ART) ratio, or the number of times per year that your business collects its average accounts receivables.
Net Annual Credit Sales ÷ ((Beginning Accounts Receivable + Ending Accounts Receivable) / 2)
For example, if you have an ART of 10, that means your average account receivable was collected in 36.5 days.
This calculation evaluates your business's ability to issue credit and collect funds in a timely manner.
A high ART ratio can indicate that your company has an efficient accounts receivable collection process while a lower ratio can signal the need to reassess your collection strategy as well as to evaluate what clients you are extending credit for longer periods of time.
This calculation allows for a faster evaluation of accounts receivable than the A/R Aging Report.
One of the important steps to ensuring on-time payment is making sure all parties are on the same page regarding payment deadlines, amounts owed and payment methods.
“Be out in front of it and have the dialogue early, making sure that clients are aware of when their payments are due," said Dyer.
Typically, this conversation happens when a business first becomes a client, but it can also happen if you've updated your accounts receivables collections process or if a client is continuously overdue and you need to realign expectations.
You should also ensure that you're making it as easy as possible for your client to pay invoices. For example, make sure your invoices are clear and complete, with no missing information that might cause your client's accounting department to kick it out of the system for further review.
Studies show that the longer receivables go uncollected, the less likely they are to ever be collected, either partially or in full.
For that reason, your business will have the best chance of collecting if you are aware of any past due receivables and can act quickly.
Whomever you choose to manage accounts receivable needs to understand that they must contact the client on the first day that a payment is late.
If your company has a policy regarding late payments, gently remind the client of any penalties they may face for late payments in the future.
Firmer communication may become necessary if payment is not forthcoming within a reasonable amount of time, including emails or letters informing the client that legal action is a possibility if the payment is not received by a set deadline.
Having an open conversation with clients can not only work to build stronger client relationships for your business but also allow you to understand why the payment was late and avoid that in the future.
Another way to help manage accounts receivable is a 2/10, net/30 discount, where customers receive a 2 percent discount if they pay within 10 days, instead of 30.
“For this type of discount, it depends on the industry. If you're in a very tight margin industry where every dollar counts, that 2 percent discount could be a lot of money to your prospective client," Dyer said. “Where a business can afford it, offering and encouraging early payment is important and can be very helpful in boosting cash flow."
It is important to seek advice from either banking professionals or industry professionals to evaluate whether this would be a viable option for your business to implement, based on your specific industry, Dyer advised.
You may have a past-due client who informs you, after a few payment reminders, that they're having cash flow challenges and need an extension to pay their bill.
If this happens, consider offering the client a payment plan for their outstanding balance.
“Setting up a payment plan and being flexible is helpful, especially when it comes to long-term clients in terms of building loyalty," Dyer said.
It is also important to put the plan and its terms in writing and have both parties sign it. Also make all future sales cash on delivery (COD) until the past-due amount is paid in full.
Small businesses often come out on the short end of the stick when it comes to accounts receivable collections — especially when they are doing business with large corporations that stretch out their payment terms to vendors and suppliers — sometimes for up to 90 or even 120 days.
While working with large retailers can be great, client diversification is important, according to Dyer.
“As a bank we love to see diversification," he said. “We love when people have contracts with Walmart or Target but also with smaller customers so that it's easier to run the business in terms of cash flow."
If you have a few large clients who typically pay outside of a 30- or 45-day window, focus on acquiring additional smaller clients and ensuring they pay on time so you ensure healthy cash flow while you wait for the longer-term payments.
Banks offer a wide range of cash management services that can help you improve collections and better manage your cash-flow cycle.
One way to avoid the "check is in the mail" excuse is to implement electronic payments for your clients through Automated Clearing House (ACH) so they can pay electronically and boost your cash flow immediately.
Another tool for cash management is a wholesale lockbox, in which customers mail checks to a special post office box monitored by the bank, which collects and deposits them immediately.
You may want to consider talking to your bankers or others in your industry about the cash management tools that would work best for you based on your current clients and business model.
“There are some different ways that we look at cash management. We like to take a collaborative approach with our clients, understand how they get paid today and their client base, and from there we can recommend the best cash management tools for them," Dyer said.
By implementing cash management tools that allow you to better track accounts receivable, you can create more efficiency throughout your business, saving you and your employees time.
Whether it's through paper checks or electronic payments, the easier you make it for your customers to pay you, the faster you will get your money. We can help you simplify your collections process. Contact us to get started.
This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.