This subject could easily be a full book, if not a series of books. But I’m not going to tackle it in that much depth. The first point is, if the customer is not paying cash, and you are not facilitating financing for them with a financial institution then you are carrying the credit choice for them! How do you
A longtime customer owes you $42,000 and it’s been on your books for 76 days. What are you going to
do about it? As we face a difficult economy, and a restart what are you going to do about handling
Credit Cards of Factoring?
You can tell customers that you don’t carry accounts and they can use their credit card. But that means you pay a fee to the credit card company. Or you can accept to create an accounts receivable and then sell that note to a company (factoring). In both transactions you are paying to get rid of the responsibility of collecting money. So, if there is a cost to hand this debt off to someone else, you choose to handle it yourself? Then you need to manage it and have standards of how you will control it.
You Chose to Carry the Credit So You Have A/R
If you offer financing through an outside organization, your bank, a financing company or possibly through your manufacturer, they have standards; why wouldn’t you? If the banks and credit cards are going to charge them interest fees, then why would you not charge them late fees? How often are you writing those off and absorbing the cost of extending credit to customers? That is not a “cost of being in business” that you must absorb. You’re probably paying interest to your bank already.
Establish Credit Standards and Hold to Them
Establish a relationship with a good credit agency and work with them to determine, if the customer isn’t paying cash, and you can’t hand this off to a finance company what are your conditions under which you will extend them credit and when will you not?
How much money can you afford to extend to your customers? How much interest will it cost you? How fast can you collect and get that money back to your bank to pay your expenses and payroll? Big questions that sometimes get overlooked.
In some industries they measure the speed of turn on the money (Days of Sales Outstanding – DSO). That could be one way to look at it, or you could set a standard based on your revenue and choose that you can afford an eighth of your sales open in accounts receivable. The point is look into your industry, your financial strength and your way of doing business and set a limit. If you went to a bank for a loan, they would tell you how much they would go to and no more. When you extend credit to your customers as accounts receivable you are just giving them each a loan. What is your total limit of loaning money to your group of customers?
Identify the Problem
There are a variety of ways of setting targets of what is reasonable and controllable. Most companies look at aging their accounts receivable. In other words, how much money is over 30 days old, then how much is over 60 days old, etc. In the past I have worked with companies on setting targets for these aging categories. One set of targets we used was:
|Over 30 Days Old||15%|
|Over 60 Days Old||10%|
|Over 90 Days Old||5%|
There is no magic in these targets, but the first point is to have some. Then determine if they work for your company and finally hold to them once you set them
By Department. But setting targets for how much money gets to be how old is only a start! There are a variety of aspects in your business. How do these targets look when you just look at customer open credit in one department or another for example? If you have four departments; sales, service, parts and rental, how is the aging percentage in each department? In the past, I have seen parts department A/R aging to be pretty good, but service is really a collection problem. Sales department might have the largest volume, but also they are the product where you get the most outside financing, so they might not be a collection issue for you. Can you organize your reporting of your accounts receivable into these groups? It might give you some insight into where your real collection problems are.
High to Low. Don’t stop with just aging your receivables! Beside grouping your receivable by departments, what about looking at them from largest amount of open money to smallest. Many times, I have worked with companies where the A/R report was organized by customer account number or just alphabetically. Those don’t help you focus on where the real money is. Sort your A/R report from larges open amount to smallest. Call these people/companies in the beginning of this list. They will have the quickest impact on you cash account.
By Customer Size. This might be a little more complex, but you’ll be surprised at the results. A few years ago, I helped a client rank their customer into groups. The first group was those customers who did 40% of their business, then we grouped the customers who did 30% of the business, next were those that did 20% and last was the group who did 10%. Only a few customers were in the first category. A larger group were in the 30% category, etc. When we then aged the receivables for these accounts grouped on how much business they did with the client we were amazed. The group that did 40% of the business were not a collection problem. It seemed they were large enough that they just paid their bills and kept going. If you followed good invoicing procedures, their bureaucracy was efficient enough to get them paid. The real problem turned out to be the two groups in the middle. They represent about 50% of the revenue for this client. Sometimes they are not that large, and they are using you as their cash float! It might help to organize you’re A/R report this way and know which types of accounts are causing the problems.
Follow Up, Follow Up & Follow Up
Follow up before it’s a problem. There are a few simple suggestions that seem to make collection less of a hassle. When you are doing custom work, service work renting equipment, etc. Get a signed agreement or quotation (not estimate). When you have a signature UP FRONT, the customer knows how much it will cost, what you are charging, and you have a signed agreement that they accepted that price.
Next call within the next 7-14 days and confirm they received the invoice. I don’t care if you personally handed the invoice to them, call the accounts payable department and make sure they got it, and that it’s been posted into their system for payment. If there was any snafu in getting the invoice to them or into their system, then catch it early. This is much better than waiting 60 days before you start calling them.
Be sure that you have three people listed in your information about who approved the purchase, who their boss is and who actually handles creating or signing checks for them. With that information you have enough contacts to handle any delay on “I can’t do that until so and so approves it.”
Use a Collection Service
Letting an open account drag past 90 days or your terms is just not good business. And the longer that invoice is on your books, the older and less collectable it actually is. Have a collection company relationship, and when your people have reached that point, then send the collection problem over to professionals and write it off! That might sound like you’re losing money, but the truth is, you already lost it!