Liquidity is critical to the viability of any business, regardless of the industry where it operates.
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When your business is confronted with some past due accounts, there are several ways to help encourage payment of bills. The first step, of course, is to be sure the invoice contains the due date. Providing incentives for prompt payment will also help. You can offer discounts for payments received before the due date and you can charge interest on late payments. If you apply penalties on overdue accounts, be sure the amounts you charge fall within the provisions of the Criminal Code and the federal Interest Act. When a customer does miss a due date, prompt and courteous contact will generally produce results. This can be done by telephone, mail or fax. Document all your collection attempts by sending written notices and keeping copies. It is important to respond rapidly in case the customer does clear the account so that unnecessary delays in shipping are avoided. Your company’s credit department and the accounts receivable bookkeeper should maintain close communication.
The most extreme method to obtain payment is to stop providing goods or services until you receive full payment. But be cautious. This could damage your company’s relationship with an important customer who provides you with significant business. If it becomes clear that you are not going to be paid, you have three main choices:
1. Write-off the account if you determine that it is not worth spending more time and money trying to collect it.
2. Hire a collection agency. You will have to pay a fee or a percentage of the amount collected. Meet with the agency to discuss its procedures and confirm that the collector will not incur any costs of start litigation without your permission.
3. Take legal action. This is no guarantee of being paid, so before you start litigation try to determine the likelihood of collection. Assess whether the individual has sufficient assets to cover the debt and legal fees.
Simply put, liquidity is the ability of your enterprise to meet its financial obligations, usually with cash on hand or by converting assets to cash. It also entails making sure your business has the financial ability to continue providing goods and services without heavy discounting and collecting your receivables timely with minimal write downs and write offs.
One way to avoid sliding into a liquidity crunch is not to extend credit to customers with little creditworthiness. Your enterprise’s liquidity and survival depends on a steady inflow from timely collected receivables.
Accomplishing that requires taking cautious steps before extending credit and staying on top of collection procedures. (See right-hand box for ways to encourage credit customers to pay on or before the invoice’s due date.)
Credit policies and procedures, however, do not always ensure the cash flow to sustain a business. Without a steady stream of revenue from sales, your business runs the risk of illiquidity and therefore being unable to pay its own debts.
When a customer asks for credit, be sure that the application requires:
1. The names, addresses and phone numbers of at least three companies the applicant has had credit dealings with.
2. The applicant’s bank accounts with branch addresses and account numbers.
With this information, you can start taking action. The next steps are critical to helping ensure your customers stay on track with their payments:
Of course once you’ve granted credit to a customer, your job is just beginning. Your company’s collections manager needs to constantly monitor receivables and closely monitor slow-paying accounts. Part of that process involves balancing the benefits of extending credit, which will boost sales on paper, against the costs of carrying receivables and perhaps being unable to collect them.
There are tools to help you stay in control. Three of the most critical are:
1. Receivables Ratio. You should hold receivables for the shortest time possible. This boosts the timeliness of payments and maximizes the accounts receivable turnover ratio, or the rate at which you are collecting bills during a given period. To determine the ratio, divide net credit sales by average accounts receivable.
2. Aging Schedule. This gives you a bird’s eye view of your receivables and the due dates. It’s a straightforward way of understanding your collection efforts and highlighting overdue bills. The accounts receivable aging schedule typically includes the name of the creditor, the total due, and the amounts due in the current month, the previous month, the preceding two months and more than 60 days.
3. Average Collection Period. One of the most important measurements is the average number of days it takes to collect a bill. This is the length of time it takes to convert sales into cash and underscores the relationship between accounts receivable and cash flow.
The longer the collection period, the more you invest in accounts receivable. And a long collection period means less cash available for your company’s own needs. Remember your firm isn’t the banker so stop acting as if you are. It will only add to your financial problems if you continue doing so.
To calculate the collection period, divide the number of days in the year by the accounts receivables turnover ratio. Or you can take the average accounts receivable and divide that by the average daily sales (net credit sales/days in a year).
The average collection period is commonly used to compare your success at accounts receivable management to that of your industry peers. It can also be used to analyze your collection efforts across various time periods, and determine how well your customers are doing paying their bills when compared with your credit terms.
These are just some of the tools that let will assist you in controlling and monitoring accounts receivables. Your accountant can help you implement the use of these tools and interpret other ratios, reports and measurements involving credits and collections.