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How to Improve Your Accounts Receivable Collections

September 08, 2022

Are you struggling to collect payments from customers? Here are some ways you can improve your collection process.

Although you can’t control many things in today’s unpredictable business world, one thing you can take charge of is your company’s collection efforts. Is your business struggling to collect payments from customers? The difficult economy has put a strain on just about everyone. Here are ways you can enhance collections and, in turn, boost operating cash flow.

Know Your Collection Rate

Unless you put a number to what’s happening with collections, you’ll likely find it difficult to fix anything. Start by calculating your accounts receivable (AR) turnover ratio.

First, compute the average AR balance by adding your beginning and ending AR amounts for the last year and dividing it by two. Next, divide your annual net sales (noncash sales less returns and allowances) by the average AR balance to arrive at your collection rate.

The last step is to find a reliable basis of comparison — because the collection rate is meaningless on its own. The most obvious benchmark is your company’s historical collection rate. Has it gotten better or worse over time? Many companies have noticed a marked decline in collections during the pandemic.

A more reliable benchmark — though it may take more work to find — is the average collection rate for similar businesses. Industry trade associations often publish this information. Or you can ask your CPA for comparable data. External benchmarks can help assess whether collections woes are unique to your company — or whether they’re due to external circumstances that may be more difficult to fix.

Review Billing and Collection Procedures

Once you know how your collection rate measures up, you can brainstorm possible adjustments to your billing and collection procedures. For example, you might be able to shave a few days off your average days outstanding by:

Streamlining the billing process. Businesses can’t collect what they don’t bill, so they need to invoice customers promptly — as soon as the product ships or the service is provided, if possible. Electronic payment systems enable real-time invoices and online payment.

Catering to customers. Customer preferences may vary in how frequently they prefer to be billed (per order, monthly or quarterly), how bills are sent (paper vs. online invoices) and how they pay (manual check, credit card, auto debit or mobile payment app). Make sure your AR practices have kept up with these preferences and changes in technology. Manual processes can be resource-intensive and cumbersome, so try to convert as many customers as possible to pre-payors and automatic payors.

Offering early bird discounts. Discounts or special sale prices can help convince customers to sign up for prepayments or autopayments. They can also persuade customers that pay with manual checks to process invoices faster.

Charging late fees. On the flip side, fees can be assessed on past-due payments. However, you might consider waiving these fees if customers immediately resolve outstanding balances, as a way to build goodwill.

Contacting customers. Courtesy calls and reminder emails can help determine why customers are behind on payments. You can offer payment plans to help distressed customers catch up on overdue accounts. Alternatively, you might discover that your own company is to blame, for example, if there’s an error in the customer’s information (possibly due to a relocation or changed email address) or a dispute over the amount invoiced. Don’t wait until the next billing cycle to handle these issues.

The last resort is hiring a collection agency. Although it’s important to show empathy to slow-paying customers, you need to do what’s necessary to ensure payment. A third party may help distance you from the collection process, but it can be costly and may cause you to eventually lose the customer.

Identify high-risk customers

Before you extend credit to new customers, it’s important to review their payment histories, references and credit scores. Such due diligence can help you assess a prospective customer’s ability to pay bills on time.

You don’t necessarily need to turn away customers with poor credit, but you might want to modify the terms they’re offered, at least temporarily, to protect against bad debts. For instance, you might decide to set a limit on outstanding balances or demand prepayment for custom orders.

We Can Help

Businesses can dramatically improve operating cash flow by proactively monitoring collections, tightening up loose ends in their billing processes and conducting comprehensive due diligence on prospective customers. This may be easier said than done in today’s challenging economy, however.

Our CFO Services team can help you manage AR more efficiently and effectively. Contact us for more information.

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