What is the number one reason small businesses fail? The answer is simple – they run out of money. They do not have enough cash flow to keep the doors open. There can be many reasons for why they do not have enough cash, but one of the biggest is mismanagement of accounts receivables.
A lot of small business owners confuse accounts receivables with cash. They think money owed to them is money they have to run the company with – it is not. Every day businesses close because they are out of funds, even though “on the books” they have enough to keep operating.
An account receivable is created when a customer buys something from you, but does not pay for it immediately. When you do not collect right away you become their creditor, you have loaned them the money. How well you manage these debts will determine: cash flow, company stability and growth, your ability to get loans, capital improvement expenditures and salaries/bonuses.
Here are 3 ways to effectively manage your accounts receivables.
The best way to control debt is to not accrue it in the first place. A growing trend in small business is to require new customers to “prove” their credit worthiness for the first few orders. They are asked to pay via COD, credit card, on-line merchant or very short terms (7 days). Once a good relationship is established the client is offered the “benefit” of credit. Credit is a privilege, not a right.
This is not possible in some industries, while in others it is the way of the future. Contractors are notorious for their tactics – start a company, pile up massive debt, file for bankruptcy and repeat. A little bit of vetting can go a long way towards protecting yourself – not all sales are good ones, and some should not be made.
Establish a strict credit and collections policy
Establishing a clear credit and collections policy will help keep your risk low. A lot of owners balk at this suggestion, ant it is a mystery. The would not let a customer steal $50 off their desk, but would let him owe $5,000 180 days out. Be sure to include the following in your policy.
- Set the lowest possible DSO (Days Sale Outstanding) for each customer based on their track record.
- Create and update customer track records based on: on-line databases and resources, BBB ratings, credit checks, payment history with your company, etc.
- Assign an employee to monitor and instantly follow up on overdue payments. The longer you let a customer go without paying the less likely you are to be paid. He will not think it is important to pay if you do not think it is important to collect.
- Clearly state payment terms on all paperwork (i.e. warranties, service agreements, contracts, invoices, bills, receipts) and give a specific due date.
- Cut off credit to overdue clients, sooner not later. It is not good business to extend credit to clients who are all ready behind; it just gives them a chance to get further behind.
- Charge interest on overdue accounts.
Make following policies and procedures a mandate for everyone
All policies and procedures should be understood and followed by everyone, you included. Cash flow is the lifeblood of your business and an effective accounts receivable system is one of the things that will keep it flowing. Create a company culture where everyone is aware of how important it is to the success of the company and to their jobs.
By actively monitoring your accounts receivables you: make sure you get paid for your hard work, maintain a steady stream of cash and keep your business open. You are running a business, not a charity. Do not let other people increase their cash flow at your expense.
At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information: