Accounts receivable management is the efficient control of resources, such as cash, readily available by firms through managing credit policies and the debts owed to the firm by individual or commercial customers.
Effective management of accounts receivable is a defining feature that makes or breaks the success of a firm, as it directly affects cash flow and the ability of the firm to effectively manage working capital. Company sales and profits, the force that drives a firm, have a major impact on a company’s liquidity.
If a company is not able to sell a product or service, it will not generate revenue. When a company makes a sale “on account,” it generates an asset in the form of accounts receivable. Accounts receivable are promises from customers to pay at a later date for the product or service currently delivered.
According to Atradius, nearly 4 out of every 10 invoices (40%) in the United States get paid late. With these late payments of invoices, there are several ways to manage your accounts receivable more effectively to avoid late payments and probably bad debts.
7 Ways to Improve your Accounts Receivable Management Process
These tips will help you improve your accounts receivable management process and avoid bad debts. They include the following:
1. Assessing Your Current Accounts Receivable Process
A great way to kickstart the improvement of your accounts receivable (A/R) process is to evaluate its current effectiveness. Start by checking your DSO (days sales outstanding) figure, which tells you the average number of days it takes to get paid after making a sale.
If it’s taking longer to get paid, your DSO figure will be higher. If your DSO is similar to or better than the industry average, you’re doing okay. But if it’s much higher, you probably need to take a closer look at your A/R process.
An excessively high DSO figure will put strain on your cash flow and may lead to an increased reliance on borrowed funds. Calculating your DSO is easy. Divide your A/R figure by your total credit sales over a certain period and multiply the result by the number of days in the period.
Another method of assessing the effectiveness of your A/R process is to identify the different stages that a typical sale goes through before payment is received. Map out your current procedure and pinpoint which stage is the most time-consuming. Chances are, this is where the process is being held up.
For example, you may find that the billing process is taking too long due to inefficiencies in data transfer between departments. This method can be useful in determining which specific aspect of the A/R process requires improvement.
2. Establishing Clear Payment Terms
Make sure that those who owe you for your goods or services clearly understand when payment is due. The way you keep track of invoice payments and due dates can be handled using simple office tools or by using good accounting software.
Results from a recent survey found that customers expect about 45 days to pay an invoice. Generally, a 30-day term is common, with a small percentage offering 1%/ 10, net 30. Also, consider using customer discounts for early payment to encourage it.
If late payments become a problem, it may be worth it to use a collections agency to enable accounts receivable turnover. This is the number of times a year that a firm’s average receivables are converted to cash. Ideally, you should be able to tell when payment is due on any particular invoice at a moment’s notice.
Remember: An aging schedule is a useful tool to track which payments are overdue. This could be anything from a handwritten list to a full-fledged report using accounting software (accounts receivable management software).
Finally, when working on payment terms, it might be worth it to see what terms your competitors are offering. If your terms are significantly stricter, customers may consider it to be more worth their while to take their business to the competition.
3. Diversify Payment Options
Being flexible with payment options can speed up the process. So, you should try as much as possible to provide different payment options to your customers to help them clear their debts faster.
To achieve this, you might consider accepting more credit cards, allowing phone payments with credit cards, accepting purchase orders, and offering direct debit along with traditional checks. Some businesses might even try newer options like PayPal or Bitcoin.
While offering these options may incur additional costs, the potential benefit of receiving a quicker payment often far outweighs the costs.
4. Implementing Effective Invoicing Practices
One of the most essential improvements in the invoicing process is transitioning from paper to electronic invoices. The cost of processing a paper invoice has been estimated to be as high as $30 compared to approximately $3 for processing an e-invoice.
The accuracy, speed, and automation that come with an electronic invoicing system far outweigh those of traditional techniques. Automatic generation and dispatch of e-invoices reduces the delays that can exist between a sale/delivery and the creation of an invoice, minimizing the time it takes for a company to receive payment.
Furthermore, e-invoices are easier to track, monitor, and follow up, reducing the evidence of lost or missing invoices in a paper trail. The timely production and delivery of invoices is often one of the most crucial organizational activity points.
If a company’s invoices are delayed, unclear, or incorrect, this will have a direct and significant impact on how incoming payments are managed and the impact they have on overall cash flow.
5. Utilizing Technology for Streamlined Accounts Receivable Management
In accounts receivable management, the more automatic the process, the better. Therefore, you should automate accounts receivable. Devices and software can help to decrease the effort required by office staff, saving time and money in the long run.
For example, Electronic Data Interchange (EDI) is now an established method by which organizations can facilitate the transfer of invoicing and other transaction data.
An EDI-integrated solution can help to streamline the administrative processes involved in the collection of accounts receivable by providing a mechanism for the automatic matching of remittance advice with open invoices, reducing the need for payment allocation activities.
Larger companies can also consider outsourcing accounts receivable functions to specialist service providers. An increasing number of accounts receivable outsourcing companies are armed with state-of-the-art technology infrastructure and staffed with experienced personnel with the objective of improving debt recovery performance.
Specialist service providers can offer accounts receivable software, which can be an attractive solution for those wanting to maintain debt recovery operations in-house.
6. Establishing Effective Communication with Customers
Effective communication is a vital factor in the collection process. Establishing good initial communication and a relationship between the credit sales representative and the customers can help prevent misunderstandings regarding the credit terms.
The credit sales representative must work together with the customer to find a payment term that is acceptable for both sides. They should be flexible in terms of the payment method.
For example, some customers are willing to pay extra charges if they are allowed to pay in installments. However, there are also customers who are willing to pay a lump sum but want to get a discount.
The credit sales representative must analyze the situation of each customer. The key here is to find a settlement where the company still gains a profit but does not burden the customers.
7. Streamlining Collection Processes
By any standard, the ultimate goal of an accounts receivable department, and the one by which its success will be measured, is minimizing the investment in accounts receivable.
As a general rule of thumb, collection costs should not exceed 10 to 15% of the money collected. However, this may vary according to economic conditions and the type of industry.
As the cost of capital rises, it becomes increasingly expensive to carry past-due debt.
As a matter of fact, we need to reduce how much we’re investing in receivables. There are a few ways to do this: outsourcing credit checks to lower bad debt, giving discounts to customers who pay early, and using debt collection agencies.
When evaluating the cost of carrying debt, it is important to keep in mind the Weighted Average Cost of Capital. This value represents the average rate of return required for investors. Any investment that returns less than the WACC is actually destroying value.
The opportunity cost of this capital investment is the potential return that the firm forgoes by investing in this project rather than its next best alternative.
Conclusion: Automate Accounts Receivable
Learning how to manage accounts receivable is the most important thing for a business. The success of managing accounts receivable can be seen in how the business can increase the collection of credit sales in accordance with the specified time and minimize losses due to failure to collect credit sales.
Effective accounts receivable management can increase sales turnover because it can provide convenience to customers in making credit purchases. Besides that, it can also result in reduced bad debt expenses.