Your Accounts Receivable is talking to you, are you listening?

Business to Business Accounts Receivable Management typically is not a topic that most business owners or managers talk about; until there’s a problem. It’s an easy topic to ignore; you find/retain/lose customers; you make/sell stuff and then, hopefully, you collect the amount you sold the stuff for, right?

When running a business the assumption is – you do everything right at the front end searching for and
finding new customers and meeting your customer needs, and the back end will take care of itself – your customers pay on time for what they bought.

That’s how you’d like it to work; but, how is that working for you now? Your Accounts Receivable is talking to you, are you listening? If your operation is not performing as you’d like, you may be searching for answers. Is the quality of your products/services equal to or better than your competition? Is your pricing equal to/better than your competition? Are you expanding or consolidating your products/services to meet the perceived needs of your customers?

How does your Accounts Receivable tell you what you need to know? First, look at your Accounts Receivable Portfolio – on a regular basis. Customers that pay slow or carry extended past due balances just may not be “deadbeats” (a topic for another discussion). Look at your Accounts Receivable a couple of different ways. Benchmark your Accounts Receivable by using a spreadsheet to track the aging bucket totals. No matter what’s going on, benchmarking is a critical tool. You’ve got to measure where you’ve been, where you are and where you expect to go.

There are a couple of key elements to benchmarking Accounts Receivable. The first is Past Due Bucket values in dollars and by percent of total due. Another key benchmark element is Days Sales Outstanding (DSO). There are a couple of different calculations when determining DSO. You can simply calculate the average daily sales and divide that number into your total A/R. Or, if your business has a seasonal impact factor, then use a rolling average of both Sales and A/R; say averaging 90 days of sales; per day; and 3 end of month A/R totals as a way to smooth out seasonal impact. Individual industries will have different methods. It’s best to check with your trade association or accounting firm what works best for your particular business. But once you’ve decided on a DSO calculation method stick with it, don’t make changes downstream unless you have a really strong case to do so.

So, benchmarking is one way Accounts Receivable talks to you; by reviewing where you’ve been and where you are you can pretty much tell where you are going. It’s critical when putting your budgets together and forecasting things like cash flow.

Another data element to measure is write-off history as compared to A/R totals and A/R bucket totals. Once you have developed enough consistent data working with your benchmark tool you can then start to predict write-off’s based on some basic assumptions. You’ll be able to properly set up bad debt reserves and develop strategies to adjust your cost of sales/pricing practices. First, have several years of actual write-off history and keep enough detailed information that allows you to quickly interpret what was written off and why. Of course, if you can determine this, it goes a long way in avoiding the same mistakes in the future (again, a topic for another discussion).

First identify and qualify your present High Credit Risk customers. These customers pose the greatest threat to becoming a bad debt. So you want to minimize the impact of High Credit Risk customers. This can be accomplished in many different ways. To follow best business practices you typically want to reduce the reliance of High Credit Risk customers. With many companies this becomes one of the most difficult challenges they face. The desire to sell and service as many customers as possible requires the ability to allow a certain level of risk exposure while controlling costs by minimizing factors like bad debts. You are driven by competition, conditions of the market place and your level of tolerance in dealing with the impact of High Risk Customers.

Another area where your Accounts Receivable talks to you is deductions and disputes. Just a few reasons deductions are taken by customers are quality, quantity, pricing, delivery and packaging. Again, not all customers that take deductions do so as a matter of common practice. Many times deductions tell you what’s going wrong throughout your entire business model. Deductions should be isolated on Accounts Receivable and categorized so that further work can be done to alleviate or at least reduce the issues causing deductions. Deductions become an administrative headache if not addressed timely, accurately and with a level professional customer service support. Pay attention to deductions and disputes; make it a senior management priority.

Finally, you must be consistent with your review process when using the above tools to keep score of your Accounts Receivable. Set up a regular time to evaluate Accounts Receivable. Make sure the benchmark analysis is completed as soon as the month end report is produced. Almost all accounting systems allow for real time access to Accounts Receivable information. The staffers directly involved in the management and control of Accounts Receivable should quickly be able to produce reliable, timely information to meet Management’s needs. Looking at a month end Accounts Receivable aging 3 weeks into the following month has little value. Make sure your staffers understand the importance of timely information and that any critical customer information that has an adverse or positive impact is quickly reported up the chain of command. Another suggestion, if its’ bad news coming from your Accounts Receivable portfolio, don’t “shoot the messenger” (that being the person directly responsible for managing Accounts Receivable). Proper training and guidance of the staffers directly involved with Accounts Receivable will provide Management with important, decisive action options.

Accounts Receivable generally is the largest or second largest asset (behind inventory) on companies’ balance sheets; so when it talks to you, listen.