Don’t let Accounts Receivable kill your Business!

It is a sad paradox that many profitable businesses fail every day or struggle to stay afloat, despite having successful products or providing state of the art services. The reason behind the paradox lies with the fact that, although a business may be profitable on paper – sales are greater than expenses – its cash flow is negative. All that paper profit means nothing if you cannot convert it into cash.

The biggest cause of negative cash flow is usually accounts’ receivable, or debtors – the amount that you are owed by clients who you have invoiced or billed for products sold or services provided to them. Whilst there are some businesses who sell on a cash only basis, or insist on payment in advance, many other companies operate in circumstances where some form of credit is given to clients, and they have 14 days, a month, or longer, from invoice date to make payment.

That is when problems begin to mount. Late payment to vendors has become an endemic problem in many countries – from the UK to the US, from Australia to Southern Europe – with, surprisingly perhaps, large companies the biggest culprit when it comes to paying their suppliers. For SMEs, late payment can have a huge impact on their business and their cash flow, and push many of them close to, or over, the wall. And given that SMEs make up the overwhelming majority of businesses in most countries, this represents a global economic problem.

Of course, aside from the problems caused by late payment of invoices, some businesses make it harder for themselves by failing to invoice customers on time – or at all! Raising sales invoices can be time-consuming and complex, especially if there is VAT involved, but it is a hugely necessary task. if you are struggling with customer invoicing, consider hiring an accountant to help with this and/or consider buying an appropriate invoicing software package. Don’t delay issuing invoices to clients – it is vital for the survival of your business.

While offering customers credit must be a commercial decision, it should not be a given. Many small businesses give credit to customers without trying to get cash upfront or considering whether doing so increases sales. They also offer credit because they are so desperate to get a customer’s trade, they will offer anything to make a sale. By doing so, they give all the economic power to the customer, encouraging clients to take advantage by extending payment terms. Companies may want to experiment by not offering credit upfront and asking for cash payment instead; alternatively they could ask for payment in advance, either in full or in part. And, if this does not succeed, offer credit for as short a period as possible – two weeks, say, rather than a month, 30 days rather than 60 etc.

If you have to sell on credit, it is very important that the timetable to get paid is shorter than the time that you, in turn, have to meet your financial obligations – accounts payable. These include suppliers, staff payroll costs, and payments to the government like VAT, taxes and social insurance contributions. Put simply, if you are having to meet your financial liabilities faster than you are collecting money from your clients, then your business is in trouble.

One way to alleviate pressure on your cash flow is to try and negotiate favourable terms with your suppliers in turn (although this, in itself, exacerbates the broader issue of overdue debtors in the economy!) It may be that there are some of your suppliers who will offer extended payment terms in exchange for your business. However, this cannot be done for all types of expenditure. Staff normally expect to be paid on time, utility bills have a deadline after which services will be discontinued, and payments to government and fiscal authorities cannot be deferred.

There are ways to encourage clients to settle on time. For example, by offering a discount for early payment (although you obviously need to calculate the available profit on any sale before deciding on the type and level of discount you can offer). Alternatively you can impose interest and penalties for late payment. Many companies include such penalties in their terms and conditions, although implementation can sometimes be difficult to enforce. Sometimes the threat itself can be sufficient to induce a debtor to pay.

If you are providing an ongoing service to a client, one way of ensuring that they take you seriously is just to withdraw the service or stop supplying them until they pay. This can be successful and will certainly limit any ongoing financial liability that they may have towards you, but could also damage your long-term relationship with your client or customer.

Depending on the size of your business and your accounts’ receivable “book”, you might consider employing the services on an invoice factoring service (these are usually either standalone companies or divisions of the major banks). Invoice factoring is a financial transaction where a company sells off its accounts’ receivables to a specialist company in exchange for cash. The factoring company then assumes ownership of all the debts and thus responsibility for collecting them. The advantage for the company selling the receivables is that they get immediate cash for the invoices, and they are relieved of the burden of chasing overdue debtors. The disadvantage is that the factor will pay a heavily discounted fee for the invoices (often as little as 80% of their face value), which, in turn, can cause its own cash flow pressure. Also some clients prefer to deal directly with the end vendor when it comes to accounts’ receivable, not with a third party factor.

Invoice factoring is also not always available to smaller businesses because a factor company may require a business to have a minimum credit score or have been trading for a certain length of time. There may also be additional costs which the factor will charge for their service, over and above their net fee (as represented by the discount they pay for their invoices), and these need to be understood in advance.

Many otherwise successful businesses have failed because they ran out of money, with cash going out of the business faster than it was received. This most often happens when there is an imbalance between accounts receivable and accounts payable; credit is advanced to clients on terms so favourable to them that payment of their invoices is delayed to the point that you cannot meet your financial obligations. With late payment of invoices an endemic problem in so many countries, do you really want to add to it? Try insisting on cash, payment in advance, or shorter deadlines for payment. And, if you must offer credit, try to make sure that you negotiate the same, or better, terms with your major suppliers. Consider discounts for early payment, imposing penalties for late settlement, and, if it is suitable for you and your industry, invoice factoring.

The management of accounts’ receivable is a vital part of any business; how successfully it is managed can mean the difference between long-term survival or bankruptcy. It should not be left to chance. Instead appropriate strategies and procedures should be put in place to make sure your clients pay what is due as soon as possible – if not sooner!

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