Cash Flow Swing Factors – Accounts Receivable
We’ve spent the last few months talking about cash flow drivers. By now you should be surfing the Cash Flow River all the way to The Ocean of the Ridiculously Wealthy. Or you should at least be feeling more confident and informed. Now that we’ve covered v, you’re ready for advanced cash flow maintenance. If you’re going to be driving cash flow, it’s crucial that you know how to make that cash: a) accessible, and b) useful.
Enter the Cash Flow Swing Factors. [Insert dramatic music here.]
There are three cash flow swing factors. Each factor impacts the timing of cash coming into and going out of your organization. These factors won’t necessarily increase or decrease the amount of cash you have overall, but — left unmanaged — they make it a whole lot more difficult to run your organization. Most business owners have experienced the misery of a terrific bottom line and no cash in the bank. We’re here to help.
The first swing factor we’re going to address: Accounts Receivable. Managing this swing factor boils down to the terms you give your clients, and how well you manage to those terms.
Here are three ways to make Accounts Receivable your newest ally:
1) Establish a Credit Policy
A good credit policy has three components:
- Credit Standards.In terms of credit history, what’s acceptable to you? What isn’t? You need to be able to answer these questions with confidence. Establish minimum standards and don’t shilly-shally. (That’s right. We just said “shilly shally.”) Check your clients’ credit before you do business with them. Ask for their references and then use them. If a potential client falls below your established credit limit, ensure that you have other ways they can do business with you (e.g., COD, credit card, retainer).
- Terms.Know your industry norms. If everyone is net 15, there is very little reason to be net 30. Set your terms to — at a minimum — match the industry.
- Discounts/Late Fees. Money is a powerful motivator, and it can be used as a carrot (offering a discount) or a stick (late payment penalties). Make sure that these discounts and penalties are written into your contracts.
2) Establish an Accounts Receivable Management Plan
A good management plan has four components:
- Term Wiggle Room. If your terms are net 30, it’s probably acceptable if a client consistently pays in 33 days. But what about 45? 60? Know when the wiggle gets a little too wiggly.
- Limits. What’s the maximum dollar amount one organization can have outstanding at any one time? Perhaps you prefer to look at it in terms of maximum number of invoices? These may vary from client to client depending on the credit standards you set in your Credit Policy.
- Collection Efforts. It’s true: squeaky wheels get attention. And it’s lovely when that squeakiness results in invoices paid timely. Know at what point in the process you are going to make your “friendly reminder” calls, when you are going to send statements, and when the situation needs to be escalated. You also need to identify the chain of escalation, and be sure to identify the people involved. Does the accounting department make the first call? If there is no response, does the salesperson or the operations manager or the president make an attempt?
- Collection Methods. We hope you don’t get to this point, but it’s a reality of being in business. You have to draw a line in the sand somewhere, and across that line you’ll find collections and small claims court. Where is that line? It’s no fun for anyone involved, but having a great relationship with a solid collections agency can make the process less painful.
Accounts Receivable is measured in Days Sales Outstanding (DSO). This is essentially an expression of how long it takes your clients to pay you. If your terms are net 30 and your DSO is 33, you’re doing pretty well. If your DSO is 62, there’s work to be done. If you have multiple lines of business with different types of clients, you may want to consider measuring the DSO separately. It will give you a clearer picture of the true cost (or benefit) of a particular endeavor.
The (ahem) bottom line: Accounts Receivable is just a fancy schmancy way of saying: “Money owed to you.” You’ve put in effort to provide the product or service to your clients. Now it’s time to put in effort to get paid for your work.
One of the best ways to gain a macro view of your business is through SG&A Reporting.
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Continue to PART TWO
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With Owl’s in-depth knowledge of our business and an awesome attitude, our business continues to run smoothly.
Owl staff understands not only the financial side of business but is able to coach us on other aspects of business decisions and to help us define alternatives.
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