Your Accounts Receivable Turnover Can Destroy Your Business
From time to time, I’ll get a client who is experiencing windfall profits but can’t figure out why they have no cash to pay the bills. They’re desperate for money to keep their business from sinking. Upon further investigation, I might find their accounts receivable turnover rate is poor.
What are accounts receivable?
Accounts receivables (A/R) is the debt your clients/customers owe you for the services you’ve rendered or the products you’ve sold. A/R can come in a variety of forms. You might extend a line of credit, invoice/bill, and/or even find your company in the position of holding onto bad debts. Bad debt refers to the type of credit extended, but you’ve realized there’s little hope you’ll see repayment. In many cases, accounts receivables are the culprit of having windfall profits but no cash to show for it.
Imagine this scenario. You run a trucking company with 2 semis. Business is good; your business is making more loads then ever before. This month alone, you estimate making approximately $50,000 in services. However, the trucking industry doesn’t pay you until 3-6 months after you’ve rendered services. In the meantime, you have to pay your employees, buy fuel, maintain the vehicles, pay insurance, and the list of expenses goes on. After a quick calculation, you figure your expenses for the month will come to $35,000. However, you still have to wait 3-6 months before your clients make due on their bill. Even worse, you have 3-6 months worth of expenses to go. Yikes!
You can apply the same scenario to any business that renders services before getting pay. It can be a graphic designer, wholesale companies that extend lines of credits, etc. Though the long-term cashflow is there, you can see how you can be upside down before you even get started.
A/R can be risky business
Accounts receivables can also be risky business. There’s always the chance a customer or borrow will not make good on the services or products they receive. Once again, we’ll use the trucking industry as an example.
Around 2011 and through 2014, the oil industry was booming in North Dakota. People in the oil industry and those connected were making money hand over fist. For those truckers who had enough working capital to weather the 3-6 months, they were sitting pretty once the money started rolling in. Flash forward to 2014/2015. As the oil prices started to drop, oil companies who hired trucking companies started to suffer financially. Many of oil companies went out of business and still are going out of business today. Those companies often left a slew of unpaid debt in their wake. If you were one of the trucking companies waiting to get paid 3-6 months out, there was a good chance you were left holding out empty hands.
Little incentives to make good
Some businesses also have accounts receivable policies that have no incentive to make timely payments on debt owed. This time around, let’s look at some professional services, such as a doctor, lawyer, or graphic designer. Often times, these types of businesses bill or invoice customers/clients after services are render. If the business has no policy for repayment of services, owners can find themselves with customers that owe for services rendered months or even years ago.
Establish best practices
Businesses can encourage customers and clients to pay on a timely manner by following some best practices. Above all, determine to whom you’ll extend credit. You might do this by running credit checks before allowing a customer to open a line of credit. It’s okay to say no to individuals with poor credit. Have clear credit guidelines. Your guidelines should include due dates, establish when a payment becomes delinquent and penalties, as well as interest on outstanding debt. Many small businesses miss the interest part when extending credit. Doing so can make your debt less important than others.
Consider this. If a customer has 2 bills of equal amounts and one bill has no penalty or interest, but the other charges 15% interest each month, which do you think will get paid first?
Develop a method for billing or invoicing. The rules established should be consistent. For instance, determine when invoices will go out or when a client/customer will be billed. You can choose to do it through your own company or even hire another company to do it for you. Just keep in mind, consistency is important, as it helps customers establish behaviors as it relates to your company.
A word of caution: Regardless of the practices you put in place. Remember… you must comply with consumer credit laws.
So… what challenges have you faced with accounts receivable?