Credit, Collections and Accounts Receivable

Best Practices and Reduced Missed Opportunity Costs

To assess, assemble and implement the Best Business Practices for the Credit Risk, Collection and Management of Accounts Receivable a number of critical factors need to be taken into consideration. As a Company evaluates this major function as part of its business development plan it must determine the relative impact Accounts Receivable has on the daily operations.

By implementing solid, time tested procedures, practices and strategies companies will reduce lost opportunity costs. Lost opportunity costs are generally unmeasured sales/profits where credit risk and/or accounts receivable management decisions prevented transactions from occurring. In other words it’s the business not gained because not all efforts were made to win the sale safely.

Bucher Financial Group’s approach allows for companies to maximize sales, improving efficiencies and reduced risk of bad debt losses. Simply, how much revenue is required to operate the business and when is that revenue required to meet obligations. The following can be used as a general guideline for any business needing to sell its products/services in a competitive marketplace.

Assess the overall market condition of the industry sector in which the Company is involved. Take a “30 thousand foot” view of where the market is in terms of competition, demand for relative products/services, customer conditions/types and the Company’s ability/quality to provide its products/services.

Next, come down from that “30 thousand foot” platform and start to “drill” into several critical areas.

Credit Risk:

Know your customers: Develop/implement and assess credit files on a regular basis including:

Develop a solid industry sector acceptable credit application form with language that provides the most adequate legal protection for the Company.

Confirm, verify and research all customers using the information provided by the customer on the credit application along with other resources independent from the customers. These resources will include banks, trade references, credit reporting agencies, trade group interchanges and internet web searches/engines. In the larger more problematic customers, on-site visits to their operations are needed for first-hand knowledge.

Develop and implement a consistent method of credit risk evaluation using the intelligence gathered through the verification and research process. There are numerous ways to conduct this evaluation.

A combination of qualified and quantifiable elements needs to be used to properly assess credit risk. Tools such as matrix driven credit scores, assessment models and detailed financial ratio analyses will provide the credit risk examiner the ability to assess risk. The end product of a properly conducted credit analysis should be an acceptable amount of credit to be extended. These credit limits or credit lines should then be a functional tool that are located within the Company’s accounting system as a trigger for potential over exposure based on the Company’s pre-determined credit risk tolerance levels. A scaling system needs to be put into place where limits of authority have been assigned based on the amount of credit being approved. A credit manager/controller would be given a set high level; then the CFO would be given a set level and the president/CEO would be given all credit requirements above the CFO level. This provides a consistent level of accountability.

Credit limits/lines should be monitored systematically giving the credit risk examiner an ongoing routine of risk re-evaluation. Credit risk rankings or ratings should be assigned to all customers so that the Company’s management can get an overview of the credit risk exposure being taken. Adjustments need to be made along with recommendations to management on a regular basis as market, economic and customer base conditions change.

The critical factor in credit risk assessment is to provide timely, accurate and meaningful summary information by the credit risk examiner to senior management. Senior management should take the credit risk exposure factor as a critical element in the daily operations and business development processes they oversee. The impact of well managed credit risk goes well beyond control of write off’s, bad debt and technical legal requirements. By providing a well developed knowledge base of the Company’s customers; support in the areas of customer service, marketing and sales will be greatly enhanced.

Collections of Accounts Receivable

The previous section provided an overview of assessing credit risk exposure. Obviously assessing credit risk takes into account the payment/performance history of customers with the Company. One of the critical elements to best managing accounts receivable is how much effort, time and expertise is required to meet the Company’s needs.

If a balanced effort is placed on credit risk management, then collection of accounts receivable should be less demanding. The level of collection activity depends on the industry sector, market conditions and level of credit risk tolerance the management is willing to take. For a collection staffer to be successful and productive, a good accounting system with ready access to billing, payment and relative support documents is needed.

An evaluation of requirements of the business, number of customers and amounts owed is needed to develop a collection strategy. Additional factors need to be considered such as customer relations, complexity of the customers’ own accounting and process systems.

Once it is determined what the Company’s cash flow requirements are and what the level of task requirements are, a collection function can be developed. As part of this evaluation staffing needs can be assessed. By looking at the credit risk evaluation process and collection process as a fully integrated function most firms combine these into one area. Depending on a number of factors either combining or separating the credit risk process and the collection process can be done.

Consistent review and follow up are required for a successful collection program to work. In addition to these elements, a progression of collection activities needs to be defined with the job description of the collection staffer. Starting with a “soft call/correspondence” program, which then escalates into a more assertive in-house program including suspension of products/services will meet 95% of the Company’s needs. In the event in-house collection practices have not produced acceptable results, the use of outside collection agencies and/or attorneys may be the best next step. The use of collection agencies can be debated depending on the quality of the in-house staff and other factors. However, if the Company maintains good credit risk practices, has a solid in- house collection function it may be best to use attorneys for the most severe collection requirements. Collection agencies can be used when a contingency fee-based agreement is in place and it’s simply more cost effective versus using an attorney.

Bad Debts

After any responsible company has taken all of the measures outlined above, in a competitive marketplace and deteriorating economic conditions bad debts will still occur. Credit risk and collection decisions will be made that may not cover every conceivable risk. In fact, once the Company properly assesses its business model and has determined the proper level of risk it’s willing to take, the eventual write offs may represent simply the cost of doing business. Too restrictive credit risk practices will have a negative impact on potential business growth. It should be made clear where the management wants to set its level of acceptable write off’s.

Bad debt and write off history is essential to understanding where to set proper bad debt reserves and the related bad debt expenses. Generally, a 5 year look back at the history of bad debts and write offs will provide enough statistical information to plot out where current and future reserves and anticipated expenses should be set. However, in order to develop a more defined bad debt reserve and bad debt expense it’s important to assess the current condition of the accounts receivable portfolio. An analysis of the aging buckets should be conducted by benchmarking their status on a monthly basis. Generally, any balances over 90 days past due should be considered as part of a bad debt reserve. Included in this analysis would be the large seriously past due accounts. Any account where the balance has been referred to an attorney or collection agency should be fully reserved. Any high volume, high credit risk rated account should have at least a portion of its accounts receivable balance in reserve. In addition to these specific accounts; a general bad debt reserve should be maintained by using a calculation of past performance of non-specific write-off items. This covers smaller accounts, miscellaneous adjustments and basic housekeeping issues.

The function of a write off of course has a direct negative impact on the profit/ loss of the Company and the amount of bad debt reserves impacts the balance sheet. So the same level of authority applied to setting credit limits needs to be applied to whoever has authority to write off balances. For internal accountability/revenue control purposes these thresholds should be part of the policies and procedures developed for the accounting area.


The credit risk, collection and management of accounts receivable is a quantifiable/measurable function. This area should be considered one of the profit centers the Company maintains. Since the actions that occur within the area of accounts receivable can have significant impact on profit, cash flow and balance sheet activities basic tracking information should be part of the financial review process.

Benchmarking accounts receivable should be part of this financial review process in order for management to have a clear picture as to know the quality of accounts receivable. The benchmark analysis should include monthly accounts receivable totals with buckets showing current, 1-30 past due, 31-60 past due, 61-90 past due and over 90 days past due. Comparisons to prior month, prior quarter and prior year is the typical look back period. Also included in this analysis would be a comparison of days sales outstanding (DSO) which will track sales fluctuations as compared to accounts receivable balance fluctuations. There are a number of methods to calculate DSO. The best way to determine what method of DSO calculation to use is find out how the industry sector calculates DSO. Many times industry sectors maintain credit exchange groups that would provide this information.

As mentioned previously bad debt actual write off’s, reserve and monthly allocated expense (accrual) should be tracked to determine past trends and predict further expectations.


Proper management and oversight of credit risk, collections and accounts receivable is a critical function of the overall business operation. It requires the proper level of time, talent and expertise to provide a quality level of service. Proper management of this area will help grow a business in good times and help protect it in down times. Many companies fail because not enough time, talent or proper expertise is applied. Conversely, companies that maintain a properly staffed credit, collection and accounts receivable function can spend more time and effort in developing business opportunities. Reduce lost opportunity costs by capturing all available sales without unnecessary risk.

Presented by: Tom K. Bucher, President Bucher Financial Group

Phone: 800-964-1353