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Article: Are You Tracking Accounts Receivables?

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Are You Tracking Accounts Receivables?

Shrink the AR cycle and stop dipping into your line of credit
By Randy Southerland

Reprinted with Permission from Catalyst Magazine December 2003
404-760-1220 | www.catalystmagazine.com

It’s a simple, but often over looked fact of business life; you can have the greatest product in the world and the smoothest talking salesmen around, but if you don’t get paid you really never made a sale.

Consider the cautionary tale of a small toy manufacturer. One day it was celebrating a massive sale to a certain well-known retail chain. Not long afterwards company officials watched in horror as the big client slipped quietly into bankruptcy protection. With so much – as yet unpaid for – merchandise tied up in that client the very survival of this tiny firm was clearly in doubt.

For most businesses, the situation with accounts receivable (AR) is much less dramatic. With many customers a few slow pays – or no pays – doesn’t raise the blood pressure of company execs. Yet, the number of days it takes to collect AR has a significant effect on the health and profitability of the company.

An economic downturn drives the AR collection day average up as companies find it harder to pay their bills. At the same time, many larger corporations are deliberately lengthening their payment cycles. While accounts may carry a net 30-day term, the actual time taken to collect is often significantly longer.

While this tends to be an unspoken practice only whispered about in corporate finance offices, other large companies with buying clout are bluntly telling their vendors that the terms are now net 90 or even longer. Caught in the vice of economic realities, they often have little leverage to change these polices short of giving up what may be their biggest customer.

The dilemma is obvious. If AR days increase too much there may not be enough cash to keep supplies rolling in and the workforce paid, forcing the company to seek loans or dip into a line of credit. A long AR cycle also can seriously hamper the growth potential of the business by starving it of the cash it needs for investment in upgraded equipment or expanded facilities.

After several years of the down economy, accounts receivable is generating heightened interest. For many firms just getting a handle on their AR is the first step toward needed improvement.

"We’ve found that a lot of companies don’t track [AR averages] because they don’t really want to know how great it has become," says Ron Hollis, president and CEO of Quickparts.com and president of the Atlanta chapter of Young Entrepreneurs Organization (YEO). “I’m not sure companies really keep up with it that much – other than to see how much they have in the bank. They might look at their AR, but they don’t track the true days it takes to collect.”

His company began tracking their average day sales receivables on a weekly basis to determine just how well they were performing in this area. By keeping close tabs on how long it actually takes for an invoice to be paid after it reaches the customer, Quickparts.com had a benchmark by which to judge collection performance.

As a manufacturer of custom parts, Hollis knew that his company was already in an industry with an unusually long collection cycle.

"The industry average is probably around 60 days anyway, depending on who your customers are,” he explains. “Even through our terms are net 30, our corporate objective is to have a 40 day average sales receivable [cycle]."

By tracking the AR cycle Hollis knew that this measure had been getting progressively longer over the last two years. Collections were running at 38 to 42 days, but suddenly the company found itself struggling just to keep the average less than 50 days.

In order to get that number down and speed up payments from customers in the face of a worsening economy, the company needed to find new ways of encouraging payment. The answer came in an aggressive campaign to encourage the use of credit cards for payment of invoices.
This approach offered advantages not just to creditors, but to customers as well. In fact, many large corporations – such as GE, Whirlpool and Hitachi – that are Quickparts.com customers, were already pushing payments to charge accounts. Within a short time a full 25 percent of payments were being put on plastic.

"That came purely from a very aggressive effort to get it to that number," says Hollis. “That allows our net average day sales receivable to run around 40 days. If you take out credit card sales, our number would be about 55 to 56 days. It has a significant impact.”

Credit cards, however, are a less than perfect replacement for the check or bank draft, say those who encourage their use. Often they have a fairly low limit for processing sales – perhaps $2,500 to $5,000 per day. For large invoices that often means sending through several charges over a period of time. Merchants also must contend with paying a percentage on sales, although that percentage can sometimes be negotiated lower.

{A Level 3 Merchant Account can significantly reduce the cost of processing business, corporate and government purchasing credit card payments}

While finding new avenues for customers to pay can be advantageous, simply tightening up internal procedures can sometimes generate cash faster.

It can be simple stuff like starting to bill daily or weekly instead of once a month,” says Verne Harnish, founder and president of Gazelles, Inc. an outsourced corporate university for mid-size firms. “When they do send the invoice out they will either e-mail or fax a copy immediately to the person they’re mailing it to. That way, if there are any problems with the invoice they can alert you.”

Just verifying that the customer has all the information needed to pay the invoice often avoids delays and it gives companies the opportunity to spot potential trouble such as a customer who’s having cash flow problems.

"If a company is sticking to sending [invoices] once a month, they [need to make] sure it arrives at the end of the month instead of the beginning of the next month so that it gets in the payable cycle," explains Harnish. “You can be off by a few days and miss an entire monthly payable cycle.”
ThinkFun, a leading manufacturer of mind challenging games was able to improve its collection rate by more than 20 percent by becoming more efficient in invoicing and keeping closer tabs on payment times for its AR.

"This stuff isn’t rocket science," says Ralph Cuomo, ThinkFun’s chief operating officer. “It’s just getting back to the basics by putting a much greater level of attention and focus on our processes.”

While many companies blame their customers’ lack of payment procedures for delayed payment, it’s often the biller’s internal processes that need to be improved first.

Soon after joining the company Cuomo instituted a weekly meeting with the head of ThinkFun’s finance group and its AR manager to review the status of collections. During these sessions they were able to examine who was paying and who wasn’t. They could consider strategies for dealing with late payers – such as putting a hold on orders already in the pipeline.

The company also developed polices for managing collections that included timelines for making calls, writing letters requesting payment and even turning seriously delinquent clients over to collection agencies. Moving through the collection cycle became a required activity rather than something to do be done by the finance department when they had extra time.

Making the AR function more efficient requires a commitment of resources. It becomes tempting for many CEOs to cut funding for the finance department as a cost saving measure. This move often proves to be short sighted – costing the firm cash that could be funding future growth.

"I think there is a natural tendency for entrepreneurs to abhor overhead," says Harnish. “Yet a company can spend an extra $30,000 to $40,000 a year to add someone in accounting who just focuses on getting bills out and getting them collected and their cash has increased dramatically.”
Additional discipline is also needed in the process of qualifying customers and their ability to actually pay for products and services. Bank references and supplier experiences should be verified prior to granting credit, insists Cuomo.

"If you’re just out trying to get the sale done and not paying attention to whether you’re eventually going to collect from that customer then you’ve really got problems," he says. “It’s not a sale if they’re not going to pay you for it.”

While many companies are taking longer to pay, sometimes payments can be accelerated – and pushed ahead of other vendors – simply by asking. Regular communication from the company (usually by telephone from the collections desk) can establish relationships and give the vender an insider advocate.

This person can be used to help push the invoice through the labyrinth of accounts payable.

"They find that what appeared to be impossible [to collect] was paid faster just by asking and explaining the situation," says Harnish. “Companies have been amazed how larger companies have decided to pay them faster – especially when they’re such a small piece of their [the customer’s] entire budget.”

In addition, by asking for bigger deposits on the front end for the delivery of good, they are able to reduce invoices requiring payment on the backend, he adds.

Many customers respond to incentives for early payment. Quickparts.com, for example, offers customers a 2 percent discount off invoices paid within 10 days of their due date. Yet, less than 5 percent of their customers take advantage of this offer and as the economy has soured that number has dropped.

Other companies’ attempt – with varying degrees of success – to charge interest on invoices paid after 30 days. Yet, as Hollis notes, if a customer isn’t going to pay the invoice, he or she certainly isn’t going to pony up interest charges.

Harnish’s company offers executives who pay upfront for its professional development programs as much as a 30 percent discount.

"That’s worth it for a lot of them – especially if they know they’re going to a lot of our executive programs over a period of a year," says Harnish.

Wild Birds Unlimited, a retail chain that sells bird feed and accessories, was able to dramatically increase its cash flow by providing added value to customers. Twice each year the company offers deep discounts to their retail customers on bulk birdseed purchases. In addition, the company provides free storage of the product, which can be collected from their stores whenever it’s needed.

"So [Wild Birds] gets two big loads of cash each year and their customers get a real discount," explains Harnish. “And they’re not having to haul it or store it. Then they generate foot traffic every three to four weeks, as customers need to come in and get what they need for that month. It accomplishes a lot of business objectives.”

In addition to reversing the AR cycle by having customers pay up front, the company can then leverage the cash in a variety of ways because it is buying birdseed only as needed to meet demand. Further, the store has a chance to cross sell each time the customer returns to pick up their seed.

Managing the accounts receivable cycle is perhaps the easiest and most direct means of finding new reserves of cash for an enterprise. While many growing companies seem to consider the state of being cash-strapped a prerequisite for growth, those who can manage their AR effectively know this simply isn’t true. Selling products and collecting revenue can ensure the firm not only grows but also enjoys a long and healthy life.