How to Manage Accounts Receivable
Paper profits are fun to look at but do nothing for your bank account or to keep your business going. In a small business, cash flow is king. (In a major corporation, cash flow is also king, but the company may be able to tap lines of credit to ease the pain of short-term cash flow crises.)
A sale is not a sale until the money is received, at least in cash flow terms. Managing accounts receivable wisely helps ensure you receive money from sales in a timely fashion. Here is a basic process for improving cash flow by managing accounts receivable.
- Get cash. Extending credit can help you build business relationships, but in effect you become a lender to your customers when you do. If you run a retail business or restaurant, for example, in almost every case you run a "cash" business: Whether customers pay with cash, check, or credit card, you receive funds from sales almost immediately. If you run a service business or a business-to-business company, the majority of your customers will assume they can pay for services later unless you require payment up front. In many cases, asking for payment up front is all it takes to turn a receivable into cash.
- Receive credit cards. Retail businesses almost all take credit cards; service businesses can do the same. All you need is a merchant account. Anyone who provides services can take credit card payments instead of billing by invoice. Talk to your bank about setting up a credit card merchant account, and require payment either up front or immediately after services are rendered. If a customer objects to paying for a service in advance, they may be willing to let you place a hold on the card for the amount of the sale; payment will be processed after the service is completed.
- Set up percentage or progress payments. If you can't get cash in full, require a percentage of the total price or cost up front. This is especially necessary in industries, like construction, where you may have to spend money to buy supplies ahead of time. Even if you don't need to purchase supplies say, for example, you're a lawyer you can ask for a retainer that you can draw against as you perform services (in fact, most lawyers require retainers in order to begin working for a client). Say you provide interior design services; you could request 25% up front, 25% after initial design plans are approved, and the remaining 50% once all services are rendered.
- Set credit limits for all customers. If it's a small customer, the credit limit should be based on the maximum amount they can afford to pay; if it's a large customer, the credit you extend should be based on how much risk you are willing to take on. Experts often recommend not extending credit greater than 10 to 15% of your total sales to one customer; extending credit greater than 50% of your total sales could ruin your company if the company cannot pay (or cannot pay on time.)
- Use discount terms to incent early payment. While offering early payment discounts probably won't cause a customer with a cash flow problem to pay early, others will be more than happy to receive a discount by paying an invoice within a specified period of time. Typical terms are "3% if paid within five days," or "2% if paid within ten days," etc. Just keep in mind that discounts will hopefully improve cash flow but will also reduce profit levels.
- Track receivables by customer. Using overall metrics to analyze accounts receivable performance is a great way to get a high-level feel for your cash flow, but make sure you stay on top of receivable performance by customer. Then:
- Use the phone first. For most businesses, a quick call reminding the customer that an invoice is due will result in payment more than half the time. Be polite; ask if payment was already sent, and if not whether the invoice was misplaced. Offer to take payment by credit card. Then, if the phone call is not successful:
- Set and follow standard procedures for overdue receivables. Once an invoice or payment is overdue, act quickly and follow internal guidelines you created ahead of time. Most businesses make one or two courtesy calls first, then send reminders, and finally let customers know that litigation will result if payment is not received immediately. Just keep in mind once you send a "litigation possible" letter, the customer is unlikely to do further business with you, so do what is necessary to collect monies owed. In other words, trying to "maintain a positive business relationship" will likely be futile.