Collecting debt from clients can often be a difficult task. No matter what you do, it is not fun and tends to only get serious attention when cash flow is needed or after everything else is done. Invoice payment is the final step in the sales process and should be planned. The longer an invoice goes unpaid, the less likely you are to receive payment. Below are some key metrics to track when managing accounts receivable and planning to receive payments on invoices.
Days Sales Outstanding (DSO)
Days Sales Outstanding, or DSO, indicates the average amount of days it takes your company to collect funds after a sale has been made. The lower the DSO is, the more cash is available for business to reinvest in marketing, sales and operations. Reducing DSO is one of the largest challenges for many businesses due to the company-wide strategy that’s necessary to do so. With improved DSO, a business’s cash flow increases significantly, allowing for funds to be allocated to growing. One simple method to reducing DSO is converting paper to email with electronic invoicing, which also reduce labor and material costs. Businesses can often reduce the collection cycle by 2-6 days after implementing electronic invoicing. Another strategy includes sending triggered reminder letters. In most occurrences, clients do not decide to avoid paying an invoice – they have just simply forgotten. This is the major challenge associated with reducing DSO. Electronic invoicing and reminder emails can greatly assist in overcoming this challenge.
Write-offs occur upon the realization that an asset, in this case accounts receivable, can no longer be converted into cash or provide further use to the business. Receivables cannot be written off until collection efforts have ceased. You can base your IRS write-offs on aging of accounts. If an account is more than six months old, the likelihood of receiving payment without a collection agency or lawsuit decreases substantially. The Accounting Minute by Sutherland lists the percentage of outstanding invoices that will not be paid:
- 26% of invoices 3 months old are uncollectable
- 70% of invoices 6 months old are uncollectable
- 90% of invoices 12 months old are uncollectable
Minimizing write-offs is a key component in improving cash flow. The smaller the write-off amount is, the happier the business remains. This means the faster you can reduce the write-off amount, the better off everyone will be. See more powerful accounts receivable statistics in the Tips to Improve Cash Flow Infographic.
Your customers make up your portfolio of business. With a portfolio, comes credit risk. We’ve all had customers with a history of paying on time and those customers that pay, but they pay late. The key to keeping a healthy cash flow and low DSO is to isolate the late payers. Later payers can have different credit limits and collection strategies applied to their accounts in order to reduce risk. Carefully monitor payment trends with aging reports and implement a credit rating system to reduce overall credit risk.
The most common way businesses track credit worthiness is to pull your customers’ credit rating from a credit-monitoring firm. There are many credit-monitoring firms our there; popular firms include Dun and Bradstreet, Experian, and Equifax to name a few. These firms allow you to check credit on an individual business, a subset of or your entire customer portfolio. If you want your customer’s credit rating updated on demand and available immediately for credit worthiness decisions, select a credit-monitoring firm that integrates with your account receivable or collections software system. One of the oldest and largest credit-monitoring firms is NACM National Trade Credit Report. The NACM National Trade Credit Report gives you a predictive score and risk rating on demand through your account receivable or collections software. An accurate picture of how a customer pays is needed to make the credit and credit limit decisions to reduce credit risk and increase your chance of payment.
Discover a Solution
It’s no secret that collecting account receivable has its fair share of unique challenges. However, overcoming these challenges becomes systematic once you’ve found an effective method to track the metrics and implement collection strategies. One proven method is the use of an accounts receivable management and credit collections system. This system should organize, categorize, and report the data so that tracking DSO, aging invoices, and high-risk clients is automatic. With a system in place, you can be proactive in your collections process and improve cash flow. You will no longer need to ask: What invoices are late and how much money is owed by aging category? How often are customers contacted directly about unpaid invoices? What percentages of your customers pay on time?
On top of providing accounts receivable metrics for analysis, a collections system should offer tools to automate mundane tasks. These tools within the system automatically highlight the accounts that need attention and schedule reminders, letters, and calls for those accounts. Sometimes the reactive approach to managing accounts receivable just doesn’t cut it. Being proactive with your collections process will allow you to see improvements in your cash flow.