Selling vs Getting Paid
What accounts receivable can tell you about your company’s future
Accounts receivable. Banks ask a lot of questions about this specific account in any business, especially small businesses. This makes sense because, in a certain way, the health and ageing of your accounts receivable shows the bank how likely are you to collect cash from past sales and (ultimately) pay them back. However, this is just one side of the spectrum. There are two types of decisions that can be made when analyzing your clients’ payment status: one from the cash point of view and the other from the sales point of view.
From The Cash Point of View
This one is pretty easy to understand. The more time it takes for you to collect money from your clients, the less cash you have at hand right now. The longer clients take to pay you back, the more money you have to look for from other sources to cover your daily or monthly expenses. You can express this in any way you want, but the bottom line is that having accounts receivable is equal to having cash that belongs to the company but has not been deposited in the bank yet.
The repercussions of these are obvious. Let’s say that you only have one client for example. If that client pays you every 3 months, how are you paying for monthly expenses (i.e. rent, payroll, phone, electricity, etc.)? You have to start thinking of accounts receivable as a financing alternative which is usually cheaper than asking the bank for a loan.
If this is what you want to achieve, you can implement one or all of the following suggestions:
- Give a discount to clients who pay upfront or within a certain time frame. This can increase your upfront sales and incentivize clients to pay earlier than later.However, you should be careful not to give a discount to clients who are past due just to try to collect cash. If you do, this might become an incentive for clients to hold off on your payment until you come “crying” for cash and give them a discount; and/or
- Stop selling to clients who have past due invoices or are past their credit limit until they pay what is owed. If a specific client hast this problem over and over again, I would suggest to even close their account after they pay you and only accept upfront payments from them.
- Include a late payment fee in your invoices. This could be a subject for an entirely new article. However, the bottom line is that you want to charge a high enough fee to incentivize clients to pay earlier but no too high so as to scare your clients from paying you if they don’t make it on time.
From The Sales Point of View
The cash part was the obvious side of analyzing accounts receivable. The sales side is a bit more subtle. Think about this question for a second: If you collect every single invoice that is due today, how many months of expenses & purchases does this cover? If it covers more than 3 months minimum, then you are most probably ok. But if it covers less than 3 months, than this could be a sign that sales have decreased.
Let’s face it. Not all of your clients are going to pay you upfront when they purchase (unless you are a supermarket or run a similar business model). Accounts receivable are a natural part of most businesses. When they decrease, this could mean that you are collecting cash from your clients. However, if they only decrease, it could be a sign that no new sales are coming through and, hence, no new invoices are being issued.
So what do you do? Easy. If your accounts receivable is decreasing month after month, understand why this is happening. Is it because you are collecting cash at a faster pace than your sales growth? Is it because your upfront payment sales have gone up? Or is it because you are collecting cash and sales have not been increasing? This is important because a company that does not sell has an expiration date.
“Trying To Serve The Client”
One final thought before you go. This article might seem obvious and logical. If you don’t sell, you will go bankrupt. If you don’t collect cash, you will go bankrupt. If you keep selling to clients who don’t pay you back, you will go bankrupt. However, there is one phrase repeated amongst many small businesses that basically eradicates these obvious conclusions. This is a phrase that I have heard throughout many of my clients and makes me nervous whenever I hear it. The phrase is “But we have to serve our client in the best way possible”.
This is true. Your income is a result of how well you are serving your customers and satisfying their needs. However, serving a client does not mean the lack of strict cash collecting policies.
If you are not a bank, it is not up to you to finance your clients’ operations. It is up to you to deliver a product or service and get paid for it on previously agreed upon terms.
Think about this the next time you are analyzing your accounts receivable. Selling is easy (in a way). Collecting cash from clients who do not want pay is actually the hard part.
How about you? Are you struggling with past due invoices or have you ever been through a similar situation in your company? Tell me about your experience in the comments below or write me an email at info@thefinancecourse.com.
Giancarlo Jiménez, founder of The Finance Course, is a Finance Professional with more than 11 years of experience in the field of Finance and more than 4 years of experience teaching about Corporate Finance in a Business School. Want to learn how to interpret Financial Statements & Ratios to make decisions at your small business? You can Sign Up To The Free Course by visiting this page.
