All too often, customers pay late — and it can be challenging to know why, or how late they will pay. Reexamining your accounts receivable can unearth efficiencies and strategies to improve AR — and, in turn, cash flow.
Have you ever waited for an invoice to be paid before paying a bill? If so, you’ve encountered a cash flow gap — and almost every business has. Closing cash flow gaps, or tightening a cash conversion cycle, gives your business the scope to thrive and grow. One way to address the problem is to isolate and examine one side of the equation: How cash flows into your business.
How common are late customer payments?
In a word, very common. In fact, well over half of invoices — 64% — are paid late. Understanding why customers pay late helps you determine the best path forward to getting paid in a more timely manner, as well as:
- Assess your customers’ creditworthiness
- Determine to whom you extend credit and the terms you offer
- Improve your collections process
- Meet your obligations and decide when to make expenditures
- Manage your cash flow
Common reasons customers pay late
Sometimes, customers are simply disorganized or lack the administrative ability to manage their bills. Other times, their delayed payments are part of a strategy for managing their own cash flows.
To the first point, 40% of financial decision makers say inefficient processes limit their ability to pay on time. Some companies require multiple levels of approval to make payments, and with many invoices passing through a department, the process easily can stall while awaiting signatures. Most businesses refuse to pay invoices that contain any errors — and delays occur as rejected or unpaid invoice are sent back to be amended. That required the company sending the invoice — perhaps your business — to balance its books before re-issuing the invoice.
An unsatisfied or departing customer also might pay late. When customers deem a product defective or a service unsatisfactory they might defer or refuse to pay, and customers might stop paying if contracts are not renewed and or relationships are being terminated. Some customers may simply be unable to pay. A previously solvent customer can encounter cash flow problems of their own that curtail their ability to pay.
Also, like your business, companies you supply or partner with are trying to manage their cash conversion cycle and tighten cash flow gaps. Your customers might be extending payments so that they keep more cash on their own books. For example, if you are paying your suppliers in cash each month, but your sales are being paid on a 30-day period, you will need to finance the cash flow gap between when you paid in cash and when you collect.
Larger businesses with more leverage can employ such tactics, sometimes prioritizing their relationships with large, powerful suppliers over smaller businesses. Their chief financial officer might need cash for speculation or investment in short-term investments
Plus, companies may not see the benefit of accelerating supplier payments if they have a slow and cumbersome approval process for accounts payable.
How can businesses encourage timely payments?
Firstly, it’s important to know your customer — scanning the array of reasons customers typically pay late above will lead you to recognize that different tactics would be more effective in particular cases. A good customer with poor admin might simply require more frequent nudging. A large corporation might be more challenging to manage.
In any case, maintaining good relationships is essential. Understand your customer’s business and point of view: What kind of challenges do they face? Are they profitable? How long have they been in business? What is their reputation? What is their current credit exposure? Communication is critical to the relationship as well, and starts with clearly stating payment terms before a contract period begins.
Analyze the data you have on your customers as well to get a better understanding of their payment history, and their preferred payment method — expand the array of payment methods you offer customers to encourage them to pay on time.
Ensure your own business’ AR doesn’t suffer from admin issues; good AR hygiene entails invoicing clearly and promptly, updating customer contact information regularly, automating payment reminder campaigns and accurately assessing customer credit risk.
Knowing your customer, understanding why they pay late, and providing tools that allow and encourage them to pay promptly can significantly affect your business’ AR — and improve your cash flow.