Strategies for managing your accounts receivable

In a modern economy, the provision of goods and services "on-credit" makes it easier for customers to buy, and easier for you to sell. Credit can help attract new customers, leading to greater market share and perhaps higher profits. However, otherwise good businesses have failed in the past when they didn't have enough cash on-hand to support current operations. So before tying up your company's cash in credit that you've extended to customers, it's best to formulate a credit policy and a set of procedures for giving credit and collecting payment.

Make a credit policy
Your credit policy is a set of basic rules that you will apply to all customers and foreseeable situations. It should list the maximum amount of credit you will grant to a customer, the payment terms (30, 45, 60 or 90 days), deposit requirements, and rules for credit checks on new customers. Ask your business acquaintances what they do, or consult with your business adviser.

You'll need to maintain a cash reserve that's big enough to continue operations, so ask yourself (and perhaps your accountant) how much money you can afford to lend to customers. With your accountant or other business adviser, you can then figure out how much credit per customer.

Selling on credit carries the risk of late or even non-payment. The cost of this risk should be built-in to the price of your goods and services. If you can determine what percent of sales will become "bad debt" you can spread that cost across the business. Another issue your policy should touch is collection: when is a payment late; will you charge interest on late payments; and how much?

Of course, you don't have to extend the same credit terms to all your customers. For instance, those who have already purchased a certain amount of goods or services from you and who have built a bond of trust with you may very well be worthy of more credit than other customers. Again, that's a business decision and you should consult with an adviser.

Applying your credit policy
Once you've set up the basic rules, you'll need to have a process for applying those rules. That process should begin with an evaluation of the riskiness of each new credit account. Check any references that the customer has provided. Payment history is a good indicator of a customer's willingness to pay: is payment usually in-full and on-time; are there any other issues? For a very modest sum, credit-reporting agencies will provide a report showing the customer's payment history and perhaps a list of legal proceedings, if any, against them. A report on past business activities however, cannot look into the future: it will not tell you whether the customer's business or industry are doing well or not.

Once you begin providing credit to your customers, you have to monitor those outstanding monies. Who will do that: you, your accountant, a member of your staff? Many commercially-available accounting packages provide "aging" reports that can alert you to those accounts that are overdue.

And how will you collect those past-due accounts? Collections is a whole process in itself and you should have a polite reminder or "statement of account" notice ready to send out which can then be followed by a series of firm reminders. In some cases, you may elect to turn a past-due account over to a collection agency which will charge a percentage of what it collects, after it collects.

But it's best to try and resolve the situation with the customer. You may be able to negotiate a re-payment schedule. You may have to accept a smaller payment sum. It's a judgement call. But studies show that the longer an account is overdue and the longer you stay out of touch with a customer, the less likely you are to receive payment from that customer.

Find incentive measures
To encourage customers to pay on time, you may want to think of inducements such as discounts for early payment, interest charges for late payments or premiums charged to customers who consistently pay late.

You can also free up cash by selling your receivables (which are assets) to a factoring company. Factoring can provide you with cash before the actual payment-due date. It's then up to the factoring company, to collect the money from the customer. A factoring company however, will buy only those receivables deemed to be reasonably secure.