5 Best Practices to Improve Your Accounts Receivable Management

Understanding the basics of accounts receivable

Accounts receivable management is an often overlooked but an essential part of ensuring your business’s profitability.

This area of accounting seeks to help you manage client invoices, process payments and reduce the effect bad debt can have on your business’s cash flow and operations.

Put simply, accounts receivable management is the process of ensuring you are paid for any products or services you deliver to customers on a credit basis.

Generally, this process involves generating an invoice for the goods delivered or services performed, sending that invoice to the customer and then monitoring how long it takes for that invoice to be paid. If the customer fails to make their payments on time, this process will then usually extend into strategies for collecting any money due to your business.

There are several risks to carrying an abnormally high accounts receivable balance:

• Unrealized Cash on Sales (Bad Debt) — Accounts that fail to make payments in full or on time are at risk of never being paid, meaning you won’t see the cash for the products or services you delivered. This can drastically harm your business’s ability to make financial forecasts and hurt both your cash flow and profitability.
• Limited Cash Flow — Lower cash flow due to regularly late or unpaid accounts can lead to problems with meeting your obligations or purchasing new inventory, potentially slowing down your business’s growth or, in drastic cases, leaving you without the money you need to make payroll or pay your debts.
• Complicated Bookkeeping — The rate at which you are paid for your services is directly proportional to the number of accounts you need to keep track of. Managing a rolling list of around 50 accounts is much easier for your billing department than having to deal with hundreds of accounts, many of which could be past due.

For these reasons, business owners should always work with their accountant or bookkeeper to ensure their accounts receivable is both healthy and well-managed.

5 best practices for improving your business’s accounts receivable management processes

Businesses with established accounts receivable processes will usually have an easier time managing their cash flows and collecting on debts than ones that don’t.

It’s critical to establish foundational best practices in your business for how you manage and approach your business’s accounts receivable.

Below, we’ll outline several tips you can leverage both when creating processes for accounts receivable management and for improving the ones you already have.

1. Create an accounts receivable aging report for your business

The first and most important step in determining where you should direct your efforts is to understand how many accounts are overdue and how much each of them individually owe.

In most cases, the solution to this problem is to create an accounts receivable aging report for your business.

Whether you choose to create this report manually or rely on bookkeeping software to create it automatically, the key benefit of this report is that it will list out both the number of days since an invoice was issued for a particular client (working back from the current date) and how much money is owed in each bucket.

Often, this report will be broken out into 30-day buckets, culminating in a final bucket showing the amount owed on all invoices older than 90 days. For example:

In this example, a business would be more likely to extend further credit to Customer A (provided they have a strong payment history) than Customer B because their account history is more current, despite Customer A having more money outstanding.

Further, this report can give you the macro information you need to make more informed decisions about your accounts receivable processes (such as being more proactive in reaching out to customers that land themselves in the 60+ or 90+ buckets).

2. Be proactive in your invoicing and make sure your customers know what they owe and when it’s due

Ensuring your business uses a proper invoicing solution is critical to collecting on accounts owed and improving your cash flow.

Your invoicing solution should provide a few simple functions to your business:

• Online Payment Options — The single most important tip for improving your ability to collect on accounts receivable is to set up an online payment portal or other solution where customers can pay their bills online.
• Automation and Regular Payment Reminders — Customers need regular reminders to ensure your invoice remains top-of-mind. Look for a solution with the ability to send out payment reminders in the event a customer misses a payment, as well as notifications about upcoming payments, new charges or other changes to their account.
• Enables Recurring Transactions — When it comes to large account values, setting up recurring transactions or payment plans is a valuable strategy for making the payment process easier for your customers.

However, along with proper invoicing, it’s important for you to be proactive in ensuring your customers know exactly what they owe and when those payments are due.

Whether you establish formal practices in your onboarding or sales processes for explaining how customers can pay or give them a call personally to discuss billing, the key here is to never leave anything to assumptions and to always be clear and precise in your communications with customers about billing.

3. Offer discounts for early payments

At a high level, accounts receivable management is a practice in maximizing cash flow. Ideally, you will sell goods or services to a customer on credit, and they will then pay that credit back to you over time through regular monthly payments.

However, you will often find that some customers struggle to make their payments, and some may not pay at all if the invoice becomes so delinquent that they forget about it.

For both situations, one common phrase applies: “a bird in the hand is worth two in the bush.”

Many business owners offer alternative or reduced payment options to customers who pay early as a means of securing the cash flow today as opposed to hoping it comes in tomorrow.

Let’s say your business does $1,000,000 in revenue per year through invoicing, and you can collect $900,000 of it with your current methods.

Now, let’s imagine that you offer your customers a 2% discount if they pay within 10 days, with a 30-day maximum due date.

If all your customers take part in this program, you will reduce your maximum collectible amount by $20,000 each year to $980,000.

However, if this program increases your collection rate from 90% (in the first example) to 91.75%, you will find that you can collect the same amount of money as in the prior example, while also providing a discounted price to the customers who actually pay. A greater increase would then improve your business’s profitability and cash flow by a significant margin.

As you can see, a small change in your collection rate through an early payment incentive can positively affect both your profitability and your customer experience, while simultaneously improving your cash flow and ensuring quicker payment for your services.

4. Work with your customers to set up monthly payment plans

Offering payment plans to your customers is one of the most effective ways to help them slowly chip away at their amounts owed while simultaneously providing you with a predictable, monthly managed source of cash flow.

Often, this strategy is most effective for long-term customers or customers with strong credit, as it offers them a way to spread the payments out over a longer period.

When establishing a customer’s payment plan, make sure to set out the terms in writing and have both parties sign the document to formalize the agreement.

Additionally, make sure to instruct your employees on how to approach future business with the customer until their bill is paid off (such as asking for cash on delivery or specifically allowing them to take out more credit from your business).

5. Regularly review your customer data to ensure your contact information is up-to-date

You can only send invoices and payment reminders to customers whose information you have on file.

While this is rarely an issue when your customers pay on a regular basis, you should be careful to keep up-to-date contact information for any invoices that are older than 90 days to ensure you maintain contact with the account holder.

The last thing you want is to call a past customer about an outstanding invoice and hear a message about the phone number no longer being in service.

In addition to reaching out to customers with overdue invoices, you should also adopt technologies or provide training to your staff on strategies for ensuring your customer database is as correct and up-to-date as possible.

Even a simple phrase at the start of each conversation such as “Just to confirm, do you still live/work at 123 Example Street with the phone number of (XXX) XXX-XXXX?” can help ensure you have the right information for all your customers come billing time.

Essential KPIs for understanding your accounts receivable

There are numerous key performance indicators (KPIs) that business owners will use to measure the effectiveness of their accounts receivable processes.

However, the two most important KPIs for most business owners are (1) how quickly your current process collects on any debts owed and (2) how long it takes, on average, for customers to pay their invoices.

These KPIs can be measured using four metrics:

• Accounts Receivable Turnover Ratio (ART) — This is a financial ratio that measures your company’s approach to extending credit to customers and your ability to collect on the money owed to you. You can calculate this ratio by dividing the total value of your credit sales by the average value of your accounts receivable over a set period. Higher ART ratios are preferred because they mean your business is more effective at turning accounts receivable into cash. Note, however, that ideal ART ratios can vary by industry.
• Days Sales Outstanding (DSO) — This is a metric that measures the average number of days it takes your business to collect the money owed on a sale. You can calculate this number by dividing the average accounts receivable during a given period by the total value of credit sales during the same period and then multiplying by the total number of days in the specified time frame. Lower values are preferred because they indicate that your business is collecting money quickly and efficiently.
• Best Possible Days Sales Outstanding (DSO) — This metric measures the average number of days it takes your customers to pay in an ideal world. To calculate this number, divide the total amount of current accounts receivable (not including any overdue amounts) by the total credit sales over a period, then multiply by the total number of days in the specified time frame.
• Average Days Delinquent (ADD) — This metric shows how long it takes customers to pay their invoices after they’re due, effectively measuring the impact that high-risk accounts can have on your business’s financial health. You can calculate this number by subtracting your Best Possible DSO from your regular DSO, with the resulting value equaling the total amount of time (in days) that it takes for your delinquent accounts to be paid, on average.

Keeping the pulse of these metrics is one of the fastest and easiest ways to spot potential gaps in your accounts receivable processes.

For example, if you and your bookkeeper find that your business had an ART ratio of 1.5, a DSO of 250 and an ADD of 140 for the prior financial year, it may indicate that your accounts receivable process is ineffective at collecting on your business’s debts in a timely manner, leading to a significant amount of delinquent accounts that are adversely affecting your business’s cash flow.

Meanwhile, if you find that your business had an ART ratio of 10, a DSO of 36.5 and an ADD of 3.7 for the prior financial year, these metrics will indicate that your accounts receivable process is effective at capturing and collecting on the cash in your accounts receivable.

Make sure to track these metrics regularly and speak with your bookkeeper about any drastic changes you notice on a monthly or quarterly basis, as these may help you identify potential accounting problems before it’s too late to mitigate their effects on your cash flow.

Work with your banker to ensure you can collect on any amounts owed

Optimizing your accounts receivable process is a powerful way to improve your business’s profitability and cash flow.

However, it’s important to note that accounts receivable management can involve lots of moving parts, meaning you’ll often have to rely on various tools to help you keep track of invoices and process any incoming payments.

Often, this means your first step when considering improvements to your accounts receivable process is to reach out to your business banker, who can provide you with the advice, tips and best practices you need to make the most of your accounts receivable process.

By working with a banker with a deep understanding of business operations, you can improve your ability to collect on any debts and provide better payment experiences to customers and partners alike.

If you’d like to discuss the different options available to your business for accepting and managing incoming transactions, please schedule an in-person meeting with a local Associated Bank representative.

By partnering with a banker, you can more readily gain access to the tools and technologies you need to more effectively manage your invoicing process and collect on any outstanding accounts receivable.