Why is staying on top of accounts receivable so important? Let’s take a look at the example below.
If total sales for the month are $1,000,000 and the profit from these sales are 10% then there would be profit of $100,000 and costs ( bills to pay ) in the amount of $900,000. When only 45% of A/R is paid within 30 days there is $405,000 to pay out for bills. ABC company also has 30 day terms. They need to pay $900,000 in bills but only have $405,000 in the bank. ABC earned $100,000 in profits for the month but is short by $475,000 to pay for materials, labor, insurance, gas, salarys, ect. ect. ect. Now ABC has to go to the bank and borrow $495,000. Banks don’t lend money for free. The cost associated with borrowing this money could be upwards of $2000 per month / $25,000 per year.
Now lets say the next month comes and goes with similar results. There is again $100,000 in profit and $900,000 in bills. This month however thee have less money to pay these bills because customers have gone over 60 days or over 90 days. So we need to borrow even more money. Do yo see where this is going? When the bank says “we wont lend you any more money” and the suppliers say we wont ship any more material until you pay your past due bills…what do you do? This is why many profitable companies fail.