Businesses cannot afford to let their existing capital go to waste. The cost of new capital and the stakes of losing the existing one are too high. It is often difficult for businesses to realize how much of the cash is trapped within their balance sheets.
Optimizing the working capital and freeing the pinned cash helps improve efficiency. It gives businesses the liquid funds needed for growth, reducing debt levels, and maximising returns.
Trade credit is common in business and the payment is usually not cleared in whole during the purchase of services or products. A recent report shows, US businesses have about $3 trillion in outstanding invoices. 68% of companies receive at least half of their payments late. Hence, this causes a notable cash flow issue.
The late customer payments lead to rising Accounts Receivables balances. The problem is that the business owners feel this is an unavoidable issue that they must work around. Although most businesses have an accounts receivable policy for when and how much to bill and collect, they fail to execute effectively, leading to rising overdue invoices.
As small CPA firms deal with a number of customers from different fields, it is paramount to rethink the current collection strategies. In this article, Finsmart Accounting – globally trusted for accounts receivable outsourcing services – will share everything critical about accounts receivable and collection process so that you can take actionable steps to make improvements.
Let’s start by understanding the common reasons for faulty accounts receivable!
Common Reasons for Faulty Accounts Receivable
Businesses, of course, do not intend to adopt weak AR policies. However, the process of Account Receivables can suffer due to several reasons. These include:
Teams fail to follow up effectively with the customers when payments are due
Leaders allow sales representatives to override the credit limit
Business owners do not provide sufficient training on how to deal with late-paying customers
Teams fail to pay attention to the accuracy of bills generated, invoices, or credit terms
There is an incorrect allocation of cash payments, leading to outstanding payments
Major AR Process Challenges and How to Overcome Them
Accounting firms offer credit to their clients for several reasons. The urge to gain loyalty and grow the customer base is among the top. However, it is important to lay out clear instructions on the payment plan and terms. Without a proper plan, there can be severe cash flow issues.
Here are some of the top challenges and ways to solve them:
The DSO
Also known as the average time needed for credit sales to turn to cash, a high Days Sales Outstanding (DSO) means that the process of completion of the debts is way too long. This also means that the client has most likely defied the payment terms. If this is higher than the market average, make sure to recheck if the offered credit plans are affordable for your business. It is important to get a new protocol and financial planning in place.
Here are the top tips to reduce the DSO:
- Rethink your strategy: Build a debt collection strategy to ensure every invoice is sent promptly, with clear terms. Deliver invoices digitally rather than through mail. This reduces the chances of missed and delayed payments. Encourage customers to set up autopay for regular and recurring payments.
- Provide multiple payment options: Different customers have different inclinations when it comes to payment of bills. Giving more than one way to make payments usually has a higher success rate of timely payments. When payments are done timely, it ensures that there is a smooth relationship between the firm and the clients.
- Encourage early payments: Incentivization is a great way to make sure that the payments are made early or on time. Along with that, make sure to impose penalties for late payments. Introduce discounts, gifts, etc to customers who are early or on time.
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Unorganised ledger
Organized invoices are key to a business. They give a clear picture of how much the business owes and by whom. It also is a reminder of the expected date of receiving the payment. Bad AR management causes cash-flow deficiency and this process gives a visibility of the monetary status of the accounting firm.
Tips for organized ledger management:
- Go paperless: Invest in an ERP if you do not already have one in place. Cut on paper checks and automate your Accounts Receivable processes. Digitization leads to a simplified process that is key in improving the ledger.
- Centralize your information: Break down your Accounts Receivable processes into smaller fragments. Avoid using too many software, invoicing, and reporting systems and tools. Matching the data from one system to another can be tricky for the AR teams. Instead, use end-to-end tools that have everything in one place.
- Audit your AR processes: After you have centralized the data, having a system where there is a regular audit of the master data can help identify customers with absurd credit and discount rates, and payment terms.
- Analyze the spending: If you want to know of a category that adds no value to your firm, group expense categories to understand how they benefit the business.
Poor communication with customers
Effective communication is key to ensuring timely payments. This is especially true at the beginning of a business relationship. It is the time when your accounting firm needs to understand the client and vice versa. Keep track of the channels and the communication that you have with your customers. This will ensure a healthy flow of information.
Tips to improve communications for better AR processes
- Update the client information: Not keeping updated records can lead to mailing invoices to the wrong address and at the wrong time. Businesses need to keep customer data updated to avoid issues like this.
- Send details after signing the contract: Once your client has signed the contract, make sure to digitally and physically send them the invoices, contract, payment terms, and due dates. Make sure to send regular billing reminders after each milestone – status of the competition of the task, new due date, etc.
- Automate the process: There are several automation tools available in the market. Make use of them to set up an invoicing schedule. The tools will also enable sending timely reminders and you will know when they have been contacted.
Lack of adequate policies
Accounting firms often have AR policies that make them suffer. Having credit incentives or adding new payment methods is just the tip of it. Lack of or incorrect analysis often leads to building policies that may not be right for the business. It is essential to build a well-structured policy that can help you identify any problematic customers.
Tips to improve your AR policies
- Review credit approval policies: As the customers and industries shift, the risk profiles shift too. The AR teams need to revise their credit terms according to the sector involved. The terms can be altered in case the business is facing a market-specific downside.
- Maintain transparency: The terms of credit should be clearly understood and accepted by the clients. Credit period, discount, and other factors should be mentioned. This is also the place where you mention any incentives or penalties associated with payment.
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- Backup your data: It is essential to have a credit analysis process for each of the customers. Methods such as credit reports and scoring should play an important role in your decision-making process. The data based on each payment option should help promote changes needed to make a foolproof system.
The Use of a Collection Agency
When dealing with unpaid invoices, an accounting firm should use a collection agency as the last resort. This move is meant to sour the relationship with the client and hence, businesses should adopt this means only when they believe that the professional relationship is over. A single or a few payment dues do not necessarily need you to find a collection agency. Besides the fact that the collection agencies are expensive, it is always better to work out the issues directly with the client and settle agreeably.
Before you are about to make use of an agency, it is important to make the client aware before transferring the debt. If this situation arises, the client has most likely been unresponsive. However, the chances of a notification of debt collection motivating them to settle are high. Before actually transferring the debt, it is best to leverage the collection agency as a threat when there is a severe delay in payment.
Improve the AR process With Finsmart
Being a better payer when it comes to business credit needs a shift of mindset among the customers. Businesses should start carefully assessing the clients’ history when it comes to payments, incentivizing and penalizing customers for early and delayed payments. It is also important to make the customers aware of the consequences of a faulty payment. In some situations, firms might even need to reduce and revoke credit limits. But just as you should not be afraid of making hard decisions, you should carefully analyze the situation before actually taking them.
Implementing strategies that work for your business is paramount in making AR processes more effective and efficient. A smooth cash flow ensures there is profitability, productivity, and customer satisfaction. Convincing customers to stay on top of the payments is a persistent challenge for most businesses, however, it should never be perceived as the “cost of doing business”. Adopting the right strategies can help take the right actions and make account balances healthy.
Ready to outsource accounts receivable services? Write to us at connect@finsmartaccounting.com
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Director Growth Strategy & Alliance
Maanoj Shah is a finance and outsourcing expert with strong Business Strategy and Scaling-up experience. Over the last 20 years, he has incubated multiple businesses and helped build global enterprises in verticals as diversified as hospitality, technology, and healthcare.
