Optimizing Accounts Receivable: The Pathway To A Business Success

Account receivable is an important item on the balance sheet because money is the lifeblood of every business. You may love your customers but love will not buy tilapia in the market neither will it sustain a business survival that is why it is good to take accounts receivable seriously. Several companies have very good formal accounts receivable policies that spells out the exact time to bill, how much to bill and when to follow up for payment in place. Sadly, not all businesses enforce these policies effectively – or even adopt the right processes at all. Businesses that prioritize sales often fall into the trap of extending credit to customers, offering discounts or ignoring payment terms if it means winning new sales. However, if management does not have a focus on working capital, no one will. They end up accidentally providing customers with free financing. This partly accounted for reasons for the collapse of many companies around the world.

While some school of thoughts may argue this is no big deal, the truth isn’t so simple. If a company needs to rely heavily on borrowing to meet its financial obligations because customers are paying late, it could incur losses on the financing charges alone. Even if that’s not the case, carrying overdue accounts receivable still has a cost. It puts you on a cash flow tightrope. Rather than having free capital to invest in growth opportunities, increase shareholder payouts, buy new equipment or introduce new products, your money is tied up on your balance sheet. The company then looks good on paper but with empty accounts.

Let’s face it. While no company intends to adopt weak accounts receivable policies, lack of planning, poor enforcement or a failure to focus on the function can result in unintended consequences. These often arise when companies lost sight of the following risk areas:

• Fail to follow up with customers in a timely manner when payments are past due dates
• Allow sales reps to override credit limits – and end up suffering losses from bad credit risks
• Neglect to provide staff with appropriate training on how to deal with late paying customers
• Don’t pay sufficient attention to the accuracy of their bills, invoices or credit terms
• Allocate cash payments incorrectly, making it harder to figure out which payments are outstanding

While there are no hard-and-fast rules for achieving this accounts receivable targets, certain best practices do exist. For example, businesses can realize cost efficiencies by centralizing accounts receivable processing, perhaps through a center of excellence which develops and enforces common practices and standards. Similarly, by automating processes, you can eliminate manual data entry errors and reduce transaction times. Implementing key performance indicators and defined metrics is also important. By adding working capital metrics to your standard revenue and profit tracking reports, you’ll get a clear picture on items like days sales outstanding (DSO), the percentage of customers who pay late, the number of invoices or customers passed through your system, unreconciled items or accounts, the monthly percentage of write-offs, collection rates on bad receivables and even collection efforts made. This will position you to track performance on an ongoing basis. Rather than relying simply on a high-level metric like DSO, try to identify the metrics that impact DSO.

I believe that these activities within the accounts receivable function if optimized, can help you free up cash and strengthen your working capital:

Customer credit approval: You need a process – clear and succinct policies for issuing credit and recovering debt in a timely fashion. For instance, you need to understand when to grant credit, circumstances that may merit overriding credit limits and situations that would justify placing accounts on hold. Determine when to assess credit limits. If a new customer is buying low volume items on short terms, a simple internal scorecard may be sufficient to assess their creditworthiness. Conversely, if a new customer is interested in purchasing large volumes on a regular basis, you may need a more stringent process, such as full background and credit history checks. Regularly review the credit approval process. As customers and industries change, risk profiles change as well.

Customer master data: Once you assign credit limits, payment terms, discounts, tax rates and return policies, and any other relevant terms (i.e. delivery address, e-mail address telephone etc.) to specific customers, those terms must be accurately reflected in your billing and collection systems. Customer master data should indicate what the customer is allowed to purchase, any cash limits that apply, payment terms, whether they get volume discounts or advertising credits, and any other relevant terms. Getting this wrong is more than a data entry glitch. For instance, if you enter an incorrect address, invoices go to the wrong place and receivables slow down. The existence of wrong details of customer information is a way to disaster. Likewise, if your master data indicates payment terms of 60 days when it should be 30, you won’t be paid on time. Recognize, too, that the master data must be updated if a customer’s credit profile changes.

Invoicing or billing: Billing is fairly straightforward, but companies often struggle in this area. Some make regular invoice errors regarding units of measure, price, customer accounts or other inaccurately reflected master data. Some fail to generate invoices in a timely fashion – or at all. Organizations should consider automation, electronic billing systems, exception reports can help to flag account anomalies (e.g.sales exceeding credit limits, discount rates above company policy, etc.).

Cash application process: Another area that causes trouble arises when customers pay their bills and payment is not appropriately allocated. To avoid this it is advisable to follow up with customers to be sure if the payment is coming from them for unidentified cash receipts and reconcile accounts on a timely basis.

It is important to engage in continuous bolstering of staff skills if they lack knowledge on how to collect amounts owing from recalcitrant customers. Negotiating payment plans that align with corporate collection policies. Whether you need to reconceive your entire accounts receivable function or simply want to improve on existing policies, the process begins by understanding your current state and conducting a gap analysis to determine how your performance compares to industry peers, competitors and best practices. From there, you can identify the steps you need to take to close those gaps.

SELASSIE A. RICH is a finance analyst and a social commentator.

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