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Ways to Maximize Profitability from Accounts Receivable

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Accounts receivable management directly affects company’s profitability and cash flow. For example, too much money tied up in accounts receivable would be a drag on earnings. There are many means to optimize profitability from accounts receivable and keep losses to a minimum.

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These include:

[1]. Minimize “billing float”, which refers to the amount of time between the time of shipment, when a bill or invoice could have been rendered, to the time a bill or invoice is actually mailed. Billing may be accelerated through electronic data interchange (EDI) rather than using the mails.

[2]. ‘‘Cycle bill’’ for uniformity in the billing process.

[3]. Mail customer statements within 24 hours of the end of the accounting period.

[4]. Mail an invoice to customers when the order is processed at the warehouse rather than when merchandise is shipped.

[5]. Bill for services periodically when work is performed or charge a retainer. Tip: Bill large sales immediately.

[6]. Use seasonal datings. When business is slow, sell to customers with delayed payment terms to stimulate demand from those who cannot pay until later in the season. What to do: Compare profitability on incremental sales plus the reduction in inventory carrying costs, which have to exceed the opportunity cost on the additional investment in average accounts receivable.

[7]. Carefully evaluate customer financial statements before granting credit. Ratings should be obtained from financial advisory services.

[8]. Avoid high-risk receivables (e.g., customers in a financially depressed industry or locality). Be careful of accounts in business less than one year. (About 50 percent of businesses fail within the first two years).

[9]. Note that customer receivables have greater default risk than corporate accounts.

[10]. Adjust credit limits based on changes in customer’s financial soundness.

[12]. Accelerate collections from customers having financial difficulties. Also, withhold products or services until payment is received.

[13]. Request collateral for questionable accounts. The collateral value should equal or exceed the account balance.

[14]. Age accounts receivable to identify delinquent customers. Interest should be charged on such accounts. Aged receivables can be compared to previous years, industry standards, and competition. Prepare Bad Debt Loss Reports showing cumulative bad debt losses detailed by customer, size of account, and terms of sale. These reports should be summarized by department, product line, and type of customer (e.g., industry).

[15]. Use outside collection agencies when net savings result.

[16]. Bad debt losses are usually higher for smaller companies than for larger ones. The company should charge back to the salesperson the commission already paid on an uncollectible account.

[17]. Factor accounts receivable when immediate funds are needed. However, confidential information may have to be disclosed.

[18]. Have credit insurance to guard against unusual bad debt losses. What to consider: In deciding whether to obtain this insurance, consider expected average bad debt losses, financial soundness of your firm to withstand the losses, and the insurance cost.

[19]. Consider marketing factors since a tight credit policy might mean less business.

[20]. Monitor customer complaints about order item and invoice errors and orders not filled on time.

[21]. Identify customers taking cash discounts who have not paid within the discount period.

[22]. Look at the relationship of credit department costs to credit sales.

The collection period for accounts receivable partly depends on corporate policy and conditions. In granting trade credit, competition and economic conditions have to be considered. In recession, you may liberalize the credit policy to obtain additional business. For example, the company may not re-bill customers who take a cash discount even after the discount period expires. In times of short supply, however, credit policy may be tightened because the seller has the upper hand.

1 Comment

1 Comment

  1. JG

    Aug 23, 2010 at 12:52 pm

    Great analysis of A/R, with some solid suggestions.

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