How to More Effectively Convert Your Accounts Receivable into Cash by Terry H Hill
Converting accounts receivable into cash is a
critical process in the development of a healthy cash flow. While booking
a receivable is accomplished by a simple accounting transaction, the
process of maintaining and collecting payments from your customers
requires a steadfast commitment to a systematic process of Accounts
Receivable Management. To more effectively convert accounts receivable
into cash it's essential that the credit and collection process be highly
efficient in order for you to shorten the accounts receivable cycle time.
The accounts receivable cycle starts with a sale (credit sales)
which in turn creates a receivable (monies due your company), and then,
ultimately converts into cash. The length of time that it takes your
company to complete this cycle, from sale to accounts receivable to cash,
is the collection period. The shorter the collection period, the less time
cash (capital) is tied up in the business process, and thus the better for
your company's cash flow.
Try to limit outstanding accounts
receivable to no more than 10 to 15 days beyond your credit terms. If your
credit terms are net 30 days, then the collection period should not extend
beyond 45 days. Keep in mind that average collection periods do vary
because of industry standards, company policies, or financial conditions
of the customer. Comparing your company's actual days of collection to the
average days of collection within your industry is a wise business
practice. Benchmarking your actual days of collection to that of your
target days of collection (no more than 10-15 days over credit terms) is
also advisable.
Your company's average collection period is
calculated by using an Average Collection Period Ratio. The ratio is
referred to as an Activity Ratio; it measures how quickly your company
converts non-cash assets to cash assets.
Average Collection Period
(ACP): ACP = Accounts Receivable / (Credit Sales/365))
A high
Average Collection Period implies that your company may be too liberal in
extending credit to your customers and too lax in the collection process.
A low number of days in your collection period could imply that your
credit and collection policies are too restrictive. This restrictive
position may be repressing your sales.
Accounts Receivable
Turnover Ratio (ART) is an accounting measure used to quantify your
company's effectiveness in extending credit, as well as, collecting its
debts. This ART Ratio is considered a Liquidity Ratio; it measures the
availability of cash to pay debt.
Accounts Receivable Turnover
(ART): ART = Net Credit Sales / Average Accounts Receivable
A high
Accounts Receivable Turnover Ratio implies that, either your company
operates on a cash basis, or that its extension of credit and collection
of accounts receivable is efficient. A low ART Ratio implies that your
company should re-assess its credit policies in order to ensure the timely
collection of monies due from the accounts receivable ledger.
A
key requirement for effective Sales and Accounts Receivables management is
the ability to intelligently and efficiently manage your entire credit and
collection process. Greater insight into a customer's financial strength,
credit history, and trends in payment patterns is paramount in reducing
your exposure to bad debt. While a comprehensive collection process
greatly improves your cash flow, your ability to penetrate new markets and
to develop a broader customer base hinges on the ability to quickly and
easily make well informed credit decisions and, to set appropriate lines
of credit. Your ability to quickly convert your accounts receivable into
cash is possible if you execute well- defined collection strategies.
Credit Process:
The initial requirement of an effective
credit management process is to have each company that you plan to do
business with, complete and sign an Application for Credit form. Your
Application for Credit form should include, the "terms and conditions of
sale," space for the prospective customer to provide information on
company background, a list of principal owners with their percent of
ownership, three to five trade credit references, and the name of their
bank(s).
It is important to personally review with the prospective
customer their projected product purchases - in both dollars and in units.
This review helps to initially assess the amount of credit necessary to
purchase the projected products. This review also helps to determine
inventory requirements based on a projected sales forecast
Collection Process:
An efficient and effective collection
management process includes well defined policies and procedures that
facilitate a more expedient, sale–to-cash cycle. The collection procedures
require "attention to detail" and should include:
• Billing:
Preparation, recording, and delivery of invoices as soon as the
product/service is delivered or installed.
• Statements:
Preparation, recording, and delivery of follow-up statements that indicate
aging of outstanding balances.
• Accounts Receivable Aging
Schedule: Preparation and distribution of an Aging Schedule that lists all
of the customer accounts that have outstanding balances. These outstanding
balances are then categorized into 4 categories of time: 1 to 30 days, 30
to 60 days, 60 to 90 days, and over 90 days.
• Telephone Calls:
Placement of courteous and professional telephone follow-up calls to
customers with past due, outstanding balances for the purpose of
establishing a date of payment.
• Collection Letters: Preparation,
recording, and delivery of collection letters with an urgent message that
demands payment and provides details of the action that will be taken if
payment is not received by a certain date.
• Recording Payments:
Posting of the amount of payment to the appropriate customer account. If
possible, it is advisable that the person performing the collection duties
not be involved with the posting of payments.
• Deposits of
Collected Funds: Preparation of the deposit ticket, along with
accompanying funds, should be deposited in the bank on a timely basis.
Factoring as an Option
Very simply, factoring is
short-term financing that is obtained by selling or transferring your
Accounts Receivable to a third party - at a discount - in exchange for
immediate cash. In most cases, the third party, a factoring company,
audits your accounts receivable to determine their collect-ability. If the
factoring company feels that your receivables are bona fide then, they
will offer to purchase the current ones at a discount. A factoring company
may also, under the right circumstances, purchase your future receivables
at discount off the face value of the receivables. The percentage discount
depends upon the age of the receivables, how complex the collection
process will be, and how collectible they are.
Once the factoring
company collects a particular receivable, they will pay you the remaining
balance of that receivable's face value, less their fee. Fees vary widely
from one factoring company to another. So, it is recommended that you do
your due diligence before engaging the services of any particular company.
Factoring fees are not insignificant when compared to the amount of
interest you might pay to a commercial lender. For this reason alone, you
should view factoring only as a short-term solution rather than a regular
outlet for collecting your receivables.
Many businesses, that need
an immediate infusion of cash in order to survive and/or to bridge their
cash flow gap, could benefit from the process of factoring accounts
receivable. Since failing businesses regularly turn to factoring as a last
resort, factoring may be viewed by many people as a negative. Although
factoring may be a great way to generate cash quickly, you should consider
the perception that factoring may convey to your customers and to others
in your industry. Your good judgment here should dictate if your company
could benefit from the quick cash flow that factoring provides, or whether
or not it would be just adding to your company's financial burdens.
Shortening the accounts receivable cycle time generates the
healthy cash flow that is required to sustain your company's growth and
prosperity.
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The goods (merchandise)
Markets are places to trade goods, and the same goes with FOREX. The Forex goods are the currencies of various countries. You buy Euro, paying with US dollars, or you sell Japanese Yens for Canadian dollars. That's all.
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Obviously, buy cheap and sell for more! The profit potential comes from the fluctuations (changes) in the currency exchange market.
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