Speeding up the collection of receivables

The cash of a business is tied up, amongst other places, in its receivables and this is the easiest place for most businesses to reduce their cash requirements. If you can reduce the average time for collection of your receivables, this will have a direct impact on the amount that you are borrowing or on cash available for other purposes. In most businesses, accounts receivable are a necessary evil. Active management of those accounts, which provide free financing to your customers, can result in significant improvements in cash flow.

There are many heavy-handed approaches to managing receivables that work but I encourage you to actively manage this critical part of your business without upsetting your customers. It is important to take some simple steps to stay on top of your customers’ payments, to avoid being taken advantage of.

Are these steps worth the effort?

Let’s assume that you have terms of “30 days net” with most of your customers but that they generally drag out payment to you so that on average they take 60 days from invoice date to pay you (i.e., 30 days overdue). If you can convince just 25% of your customers to pay on time and 25% to pay after 45 days, you will reduce your total receivables by 18.75%. This is usually a very achievable target. Apply that percentage to your receivables balance and that is the amount of additional cash that you will have in your business. If your receivables are usually about $1m, you would generate $187,500 in additional cash.

So, what are some of the management issues that need to be addressed to achieve this? Not all approaches are appropriate for every business or every customer but all should be considered:

1. Do you have a credit policy for the granting of credit to customers? If not, implement one and make sure that your customers are aware of it. Many customers will adhere to the policy once they are aware of it even if some will delay a few days beyond the limit. This is almost always better than allowing the customer to set the terms. Ensure that all new customers are made aware of the policy and expressly agree to abide by it or negotiate an “exception” as a special for that customer. If most of your customers take 60 days and you ask for 30 days and settle for 45 days, you are way ahead.
2. Both existing and new customers should be screened and credit limits set. Do not get into the trap of extending credit beyond a set limit to a customer, without negotiating terms for them paying you and staying within that limit or a newly revised limit. Nothing is worse (other than a default on payment) than having to cut off a customer without some warning if they do not manage to pay according to an agreed schedule. Consider your reaction if a supplier were to cut you off without warning. Also, offering extended terms shows a willingness to work out a payment schedule with your customer and makes them much more likely to stick to the terms.
3. Ask slow paying customers what you can do to facilitate faster payment. They should at least be aware that you are watching them and are prepared to work with them. What a great opportunity to show your good faith to a slow paying customer. There are so many situations, especially with big companies (where bureaucracy often prevails), where a simple win-win can be achieved by sending the invoice to the appropriate staff member and/or a copy to a second person, etc.
4. Remind the person dealing with your payments of your credit terms. Often the accounts payable clerk is not aware of your terms and a gentle reminder can be helpful.
5. Pester them (very politely) to pay more promptly. Your accounts receivable should have a relationship with every customer’s accounts payable and should phone them regularly, especially if they are not paying strictly within the terms. This should almost always be the nicest, most polite and friendly “squeaky wheel” in town. Developing this favourable relationship will often facilitate your account being settled expeditiously.
6. Consider cutting lagging customers off from further business (until they are within your credit terms). Doing this once often has a magical affect on their willingness to stick (closer) to the terms in the future. Of course, it is also a very powerful risk management tool. If they cannot pay, at least you have limited your exposure. It goes without saying that this must be used with a lot of discretion, especially if your customer can easily obtain the supplies elsewhere.
7. Consider whether you wish to continue doing business with them at all. This is especially effective if you have a shortage of supply in your industry. If it is known that the product is not readily available your customer should understand that prompt payment is required.
8. Consider whether you are dealing with the correct person to facilitate payment. In many companies accounts payable determines the amount to pay and to whom, based on general directions from the Controller. Create an exception by calling a senior person in your customer’s organization, someone you know, or can develop a relationship with, to ask that you be paid promptly.
9. Consider increasing your price to the slow-paying customer. Multiple price lists exist in many industries and there is often no reason why you cannot move a customer to a slightly higher pricing formula.
10. Consider offering a higher discount for prompt payment. Many businesses offer terms for prompt payment such as “2% – 10, net 30.” Some customers will stay within these terms and pay promptly to benefit from the discount. For those that do not take advantage of the discount, consider a phone call to offer them an even better discount. Tailor this to suit the occasion. Call a customer (who normally pays after 45 days), after 10 days have passed and explain that although they have missed the 2% discount, you are prepared to extend this, on a one-time basis, and give 2% for paying within the 30 days. A particularly effective method if you are in a cash crunch is to call a customer who owes a large balance and offer a discount of 5% if they pay within two days. This should be set at a level that it is so tempting that they will almost certainly take it. Of course one has to take into account the reputational impact of such a move.

Often suppliers are wary of upsetting their customer by making “collection calls” but are not offended when they receive a similar reminder. Recognize that you are on the opposite side of the table and do not be concerned about being a hypocrite. It is common practice and I would emphasize, good business practice, to have the opposite approaches to collecting from customers compared to paying your suppliers. Do not be shy to be firm, as long as you are always polite and professional.

Above all, the objective of an effective credit policy is to ensure that you are always a priority in the payment program of your customer. Almost every accounts payable function that I have come across gives preference to some suppliers and it is your role to find the way to the top of that list.

About the author

James Phillipson is a Chartered Accountant and a Principal of Mastermind Solutions Inc. with over twenty years experience in large and small businesses. He has provided financial counseling to his clients since 1996, often in the role of a Controller or Chief Financial Officer, for both public and private corporate clients. James has experience in financial roles in a wide variety of businesses and industries. This includes large corporations and many medium-sized public and private companies.

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