You know that you can improve cash flow by slowing down your payment of accounts payable. Today’s post is about speeding up accounts receivable collections.
Having a good handle on your accounts receivable is very critical to improving your cash flow, especially during tough economic times when everyone else is slowing down their payables!
The best place to start in discussing speeding up collections is to calculate A/R turn. Here is the computation:
Total Outstanding A/R
Days A/R turn =
Last Month’s B2B sales/30
If total A/R = $100,000 and last month’s credit sales were $45,000, then the daily average credit A/R for last month would be $1,500 and the average days A/R turn would be 66 days.
Here is the equation:
66 days turn =
Simply put, this example shows it takes an average of 66 days to collect this company’s A/R.
Using this example, for every day of improvement in average turn, cash flow increases by $1,500.
If this example company were to improve this their turn from 66 days to an average of 45 days, there would be $31,500 less total A/R that would be available in cash. That extra working capital would also decrease overall credit exposure as well, since 66 days is considered a pretty slow turn for many industries.
How does a company improve the average days of A/R turn? Simply put, one has to work collections in a professional and courteous but firm manner. It may take a little bit of time to train customers to pay within terms, but the reward is worth it.
Every company that sells on credit should have a policy regarding past due accounts. Accounts that go over 90 days old should be changed from a credit account to a COD account in most cases. Even though it is difficult to do, often it is necessary to turn old non-paying accounts over to a collection agency.
In closing today’s post, something that will help management better understand the nature of their accounts receivable and what portion of it may not be collectible, is to create a contra account on the balance sheet called, “Allowance for Bad Debt.” In this account, your balance sheet would show the dollars of potential bad debt on the company’s books. It is management’s best guess about what might not be collectable.
The balance sheet accounts would look like this:
Allowance for Bad Debt
The current assets are decreased by Allowance for Bad Debt (a contra account).
Bankers and others outside your company who use your financial statements will appreciate the value of the company’s A/R more when there is such a contra account. Of course, if you don’t have any debt that could be classified as doubtful, then such an entry would not be necessary!
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EXTRA: If you have questions for Sam regarding business financing, the credit market, and similar issues, please send an e-mail. Your questions will be recorded and Sam will answer the best ones in his Ask the Expert podcast show.