How do collections affect my business’ cash flow?
Does your business sell to other businesses on credit? If so, you might find yourself waiting to be paid before you are able to pay your own bills. Read on to explore how B2B businesses typically manage accounts receivable, as well as best practices around collections, and how both affect cash flow.
What is a typical accounts receivable (AR) workflow?
An AR workflow is set into motion as soon as a customer makes a purchase — i.e., your business makes a sale. Once that customer takes delivery of your product or service, they receive an invoice that details both what they owe and restates predefined terms that indicate how long they have to remit payment to you, typically 30 days. After the customer pays, that payment is reconciled against the invoice. The process begins again with the next sale made.
Effective AR management entails sending the initial invoice in a timely manner, sending payment reminders mid-month and escalating the tone and frequency of communication when sending late payment reminders if the customer does not pay on time.
How do I know if my collections process is performing well?
Collections are designed to address that portion of customers that do not submit payment on time according to the terms and due dates of an invoice. When customers pay late, your business is left with cash flow gaps — moments where you’re waiting for a customer to pay before you have the cash on hand to meet your own financial obligations. Cash flow gaps pose numerous problems for any business, risking instability and even insolvency. Analyzing your collections process to shrink cash flow gaps has broad, positive implications for cash flow management.
Your average collection period, or Day Sales Outstanding, is a good place to start the analysis. The figure is a snapshot of when you typically are paid what you owe. Calculating your average collection period helps you understand the efficiency of your collections process, and whether it effectively allows you to pay your own bills on time.
A high ratio implies a longer AR cycle and potential cash flow problems; a low one suggests your business typically is paid promptly and can maintain liquidity. Predictability is a key part of managing cash flow, and when customers reliably pay on time you can feel confident that daily expenses will be covered, and have a better sense of when to make large expenditures.
The collections process has to work for both you and your customers — while a fast turnaround is best for your bottom line, if you define terms that are overly strict it could drive some customers to a competitor who offers more convenient terms.
How can I improve my Day Sales Outstanding, AR and collections processes?
When evaluating the receivables side of your business, consider the creditworthiness of your customers and whether they are being encouraged to buy on credit. It is also prudent to determine whether sales teams are extending overly generous terms to increase sales — and if it’s appropriate. Keeping contacts up-to-date, invoicing promptly and sending reminders are all part of maintaining a smooth process.
For tips on how to assess whether your processes are effective, efficient and scalable as your business grows, download this ebook on AR best practices.
Why does it matter?
Your business can only thrive and grow when its cash flow is healthy. Slow or inefficient accounts receivable can leave you with insufficient cash to pay bills, and inhibit your ability to add staff, purchase equipment or expand locations. Gaining a better understanding of how to maximize your cash inflows, and which levers to pull to improve performance, is critical to surviving and performing well in a competitive market, for any size business.