2 Metrics for Improved Receivable Management

Cash flow is an accounting term that basically describes how the company makes and/or obtains money (Sources) and how the company spends money (Uses). SOURCES can be from Clients, investors, debt, donations, etc. USES can be anything from purchasing supplies to paying your local power bill. Anytime money goes out the door is a USE from a cash flow perspective. So, what are some good ways to make sure you can measure some of those sources and uses of money? In this series of posts, we will discover several different ways to measure and manage cash flow.
For this post, we will dive into Receivables Management. While there are many great ratios and indicators that can assist you with managing receivables, we will start with 2 great metrics: Receivables Turnover Ratio and the Average Collection Period. The good news is that your accounting tools should be able to provide this information very easily.

Accounts Receivable Turnover:

The Accounts Receivable turnover tells you the number of times per year that your business collects its average accounts receivable. This ratio helps companies evaluate how efficient they are at issuing credit and collecting funds from its customers in a timely manner. A high turnover ratio indicates the company’s collection department is seeking payment, the company’s credit policy is being followed and can even indicate the quality of the customers.

How do you measure this?

AR Turnover

Let’s look at an example:

During the first half of the year, a landscaping company has a total Net Credit sales of $1,000,000. They had a beginning accounts receivable of $400,000. At the end of June, 180 days later, they had an ending accounts receivable balance of $300,000.

Let’s put this formula to the test:

AR Turn example

In summary, the landscaping company was able to collect the average receivables almost 3 times in 180 days. While this is great information, your next question is how long does it take me on average to collect? This is also called the Average Collection Period.

 

Average Collection Period:

The Average Collection Period tells you on average how long (in days) it takes to receive money from products or services you have invoiced or credited. In this ratio, a low number is better because it means it has fewer funds tied up in what people owe, thereby allowing the company to invest in other things that will help them grow.
Lower the days that people owe, the more you will have to transform and grow. – Keith Minick

How do you measure this? The formula is:

Average Collection Period

Let’s look at an example:

Continuing with the example above, the Accounts Receivable Turnover was 2.86 times. Since we measured the first half of the year, we will make the total number of working days at 180.

Let’s put this formula to the test:ACP Example

In summary, this landscaping company may have a problem receiving money for services and products rendered. It takes on average 63 days to collect sales from credit accounts. This could create significant cash flow problems and limit its growth.

Some disadvantages to low receivable turn and high collection periods:

There are many disadvantages of allowing your customer account receivable balances to age longer than thirty days especially if your customers are not companies.  The longer you take to collect, the chances of writing the account off is increased.  All families come into hard times, and may have cash flow problems themselves.  It is better to communicate in a positive way and in a diplomatic way ask when you can expect payment.  If they don’t hear from you, your bills go to the bottom of the pile or possibly in the trash.  It is a good idea to rigorously manage your receivables. The success of your business and its ability to grow depends on it!

Some recommendations to improve your turnover of receivables:

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  • Offer a discount for early payment. For example, if services are paid one year in advance, the cost of the services are decreased by 5%.
  • Build incentives to your employees based on collections made within the 30-day period. Example; A $50 bonus each month if your current receivables are 85% of your overall receivable balance.
  • Build your commission policies in a format that only pays commissions when the accounts are paid in full. This gets your sales people involved in assisting with collections.
  • If you don’t have a collections policy, build one. You will need to educate not only your staff but also your customers.
  • Assign late fees.
  • Consider hiring a collection agency once your receivables cross a certain threshold.
  • For some product and service oriented customers, you may want to consider bringing the point of sale to the customer. Products like Square, allow you to plug into any mobile device to collect payment right when the service or product is rendered.
  • Consider stopping all service for a client with receivables past a certain time period.
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We wish you the best as you navigate your accounts receivable. We hope this has been helpful. If you have any questions or comments, please feel free to contact our CFO, Ron Minick at Ron.Minick@aculign.com. In continuation of the series, next week we will explore ways to measure and manage your payables.

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