Understanding Accounts Receivable

Small businesses and medium-sized businesses utilize accounts receivable to smooth out the transaction process and better enable customers to purchase from them.  However, while a well-tuned, properly run accounts receivable process can be a great boon to a growing business, mismanaging the accounts receivable process can have an equally devastating impact on cash flow. Indeed, cash flow is often the main cause of an otherwise healthy and sound business failing.

At the same time, while extending credit to customers comes with risks, it is completely reasonable, and often expected, for businesses to still do so. We will be discussing some methods and strategies that small business owners can utilize in their accounts receivable management process. These methods can help ensure small businesses can harness the myriad of benefits of extending credits to clients while at the same time avoiding the numerous pitfalls that can develop in the process. 

The Benefits and Hazards of Extending Credit to Clients

Before we dive into strategies for managing accounts receivable payments, we’ll start by developing a basic understanding of the inherent benefits and hazards that come with extending credit to clients and what the short-term and long-term impacts are.

Benefits of Extending Credit Payment Options to Clients

Offering credit to clients and customers can stimulate business in several important ways.

First, offering credit encourages your customers to spend more money since they have more time to pay it off. Further, offering credit can ensure that your business can compete with competitors. If one of your competitors provides credit to customers and you don’t, it can give them a significant leg up acquiring and maintaining customers.

Offering credit to customers also encourages customer loyalty. When customers are used to making payments to you and purchasing their goods on credit – thereby forming a financial relationship with and obligation to you – they are more inclined to continue buying from you. If you are invoicing them regularly and they are making payments to you regularly, it builds trust, communication, and dependence between your two companies.

Lastly, extending credit to your customers can create a certain sense of stability and consistency for your business. Instead of relying on one-time, large purchases repeatedly, it creates a continuous flow of payments due to you, which can help you project your revenues and smooth out your cash flow, assuming you are managing the accounts receivable payment process properly.

Hazards of Extending Credit to Customers

Unfortunately, providing your customers with credit also creates several hazards and risks in the process.

For one, allowing customers to purchase on credit can severely hinder your cash flow if customers continually make late payments and their invoices go past due. As such, the money you rely on from your sales may not show up in a timely manner.

At the same time, when you extend credit, you are still providing the goods to the client at the initial time of purchase, meaning your products are leaving your warehouse or store without you having the cash in hand for them. If customers default and you end up with bad debt, you can seriously impact your business’s financial health.

Extending credit to customers also creates extra tasks for businesses. For one, they must be shrewd and diligent in their investigation of each customers’ creditworthiness. This means you must have employees trained to check and analyze customers’ credit reports.

Suppose you fail to train your employees properly or fail to set clear guidelines for providing customers with credit. In that case, you could inadvertently end up giving out too much credit to businesses who are not qualified to, or capable of, meeting the required payments. This can be devastating for any business, particularly a small business.

Another task that provides credit to clients creates for your business is the need to stay up to date and diligent about ensuring customers are paying their invoices on time in line with your payment terms. If customers miss payment deadlines, you must be ready to follow up and serve reasonable late fees quickly, and if they fail to pay, you must be prepared to take debt collection measures, such as sending clients to a collection agency.

With All these Risks, Why Do Businesses Offer Credit to Customers?

There are indeed a lot of hazards and risks involved in providing customers and clients with credit. However, as noted in the benefits of giving customers and clients credit, it is essentially a necessary hindrance. There are always businesses prepared to extend credit to their clients and customers. Suppose you want to remain competitive in the marketplace, offering payment terms and conditions that suit a wide variety of clients. In that case, you are most likely going to have to provide credit to customers.

What are some Tips and Tricks for Managing Accounts Receivable?

There are many methods businesses can utilize to manage and smooth our collection of accounts receivable. Here are a few of the key touchstone methods and processes for ensuring your company is using a seamless, integrated, and smooth accounts receivable collection process.

Set Clear Customer Credit Approval Guidelines

The first step in providing customers with credit efficiently and effectively is setting clear credit approval guidelines for employees to adhere to. Businesses are often quite relaxed and lackadaisical in issuing credit, failing to set clear policies and procedures.

Policies must be established for who to grant credit to, when allowing customers to exceed their credit limit, how to address unpaid invoices and defaults, and when to send clients to a collection agency. You should also set up a policy for early payment, especially if you charge a premium or interest rate for deferred payment for goods. Having clear guidelines and procedures will enable your employees to see that they are strictly complied with.

It is also helpful to assign different credit processing procedures for low and high-volume buyers. If a customer is buying just a few units on credit, you may not need to conduct as stringent of a process in assessing their creditworthiness. They also may not need to have as great as a credit record as a business that is buying a large number of units.

Centralize Your Collection Process and Provide Diligent Oversight

Businesses often get sloppy with collecting revenues after the initial sale is made. As a business owner, you need to be diligent in setting up a system to centralize the management and processing of accounts receivable.

To do this, you should consider using a system like QuickBooks, a bookkeeping software, which serves as a centralized accounting hub for bookkeepers and employees. Through systems like QuickBooks, you can manage and track invoices, payments, due dates, defaults, and more (software like these also allow you to manage several other business accounting tasks, such as managing bank accounts, outside of simply accounts receivable) all in one place. Plus, you can send electronic invoices and receive electronic payments through various payment methods. Additionally, online payments are often preferred by customers and clients in today’s automated and technology-based world.

This software can automate invoicing, which helps reduce inconsistent billing and errors, flag accounts that continue to miss payments, allowing you to track customers’ payment practices, and generate various reports.

This is a good practice for all businesses, regardless of size. You may have a very small business and believe that a centralized, automated invoicing system is not necessary because you don’t have many clients. This is typically not true. Even if you have a startup, odds are you plan to expand and grow. The best way to accelerate and facilitate proper growth is to have clear templates, guidelines, and practices that can scale easily alongside your business. Thus, even if you have a small business now, it is always good to start building a strong business operational infrastructure that can assist you as your business grows.

Applying Cash Properly

Consistent with the need for an automated system, applying cash to customers and their specific invoices is another essential component of dealing with accounts receivable.

As payments are made, you have to make sure that you are applying the cash payment to the proper customer who made it and the specific invoices and items they are making payments toward.

This process can be smoothed out considerably by an automated system that sends invoices and receives payments.

If you are processing payments manually, you should make sure you are applying the payments on the day they are received or within 24 hours. This will limit the buildup of a backlog of payments that have to be made and ensure you can quickly identify missed payments.

Remember, the more payment methods you allow customers to use, the harder this can become, so it may make sense for you to limit the number of payment methods your customers can use.

Maintain Detailed and Clear Customer Profiles

The goal of extending credit to customers is to build a long term relationship and drive recurring revenues for your business. As a result, you should automatically expect and encourage clients to buy again and again from you.

In line with this, you should make sure you are maintaining clear and detailed customer profiles that allow you to quickly access both their creditworthiness and the history of dealings between the client and your business.

These profiles should not just include simple data points like their e-mail and billing addresses. They should also clearly outline the creditworthiness of each customer, what value of goods that particular customer is allowed to purchase, whether or not they are eligible for any sort of bulk or recurring customer discount, and what kinds of payment terms they have set up with your business in the past and/or are eligible for in the future. This way, you don’t have to repeat all this work each time a customer wants to make another purchase from you, saving your business, your customer, and your employees time. Plus, it removes room for error in the terms and credit you extend to each individual client.

These profiles can also help with continued marketing efforts, since you will know which customers you should continue to market to and what sorts of offers you can reach out to them with. For example, maybe they qualify for a special financing program that you only offer to certain customers. Having their email and a profile on them will allow you to reach out to them and inform them of their eligibility.

Given today’s emphasis on marketing and its importance to businesses’ success, these profiles can be an essential resource for your business’s expansion and development. Continuing to build these out with more and more details could pay dividends in the future.

Engage with Your Customers Frequently

Businesses, particularly small businesses, can miss payments towards their accounts payable simply because they forget about them or are unorganized. They can also try to skate by, making late payments, hoping their creditors don’t notice.

To mitigate these sorts of issues, you should maintain frequent communication with your clients. This doesn’t mean you should be calling them on the phone or talking to them frequently; it just means you should be sending them notices when they have an upcoming invoice due in, for example, a week.

Then, if customers miss payments, you should develop clear communication procedures for your employees to use. For example, how many times should employees contact a delinquent borrower? How do you want them to approach to the situation? How should they deal with argumentative customers? How many times should they be warned before they are sent to a collection agency? These are all procedures that should be formalized.

Analysis

Offering customers credit can be a powerful tool for growing your business and enticing customers to be loyal and buy more products. However, it can also be a bane for many small businesses who are unequipped to handle the intricacies and complexities of offering clients credit.

As with anything, the key here is researching and understanding the best methods for managing accounts receivable. We have discussed just a few of the most important aspects of dealing with accounts receivable, and there is a lot more to be learned about the topic. Additionally, methods can vary and change depending on what software your business uses and what it enables you to do (i.e. can it track payments made to you by customer and invoice, etc.).

Conclusion

While there are many things in business that you can just jump into and learn as you go, dealing with accounts receivable and giving credit to clients should be carefully considered before being utilized by any business. It can have significant consequences for your business and severely impact your business’s cash flow and liquidity.

The current pandemic has shown for many small businesses how difficult it can be to manage accounts receivable. Many debtors have been unable to pay their creditors due to the current economic situation. This not only puts the debtors in jeopardy but the creditors as well.

This is not to say that your business should not provide credit to customers. As previously noted, providing clients with credit can be incredibly beneficial. Instead, the most important takeaway is that research and understanding is the key. Whether that is investigating different accounting software options or setting clear policies, providing credit to clients is a process you should go into with a clear plan of attack. If you can do so, you can have an incredibly powerful tool for your business’ future growth!

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