What is Accounts Receivable Management?
Accounts receivable management, often abbreviated as A/R management, is an important part of a company’s order-to-cash process. When one of your customers purchase a product or service from you and does not pay for it in full up front, they balance they owe you is known as accounts receivable. For example, a customer can owe accounts receivable to their vendor if they purchase a product or service on business credit or as part of a payment plan.
Accounts receivable management consists of the methods and processes that companies use to 1) understand from a financial perspective how much money is owed to them from their customers and 2) go about collecting the owed payments.
It’s important to proactively practice accounts receivable management by collecting revenue to improve cash flow and help protect your company from bad debt. Slow paying customers can have a negative impact on a company’s monthly cash flow.
The way a company can understand how much money is owed to them can be as simple as maintaining a spreadsheet with the customer’s company name, invoice number(s), the outstanding amount, the date the balance is due, and, if the payment is late, how many days past due. This is a list of your “aging” accounts and so this report known as an aging report. When done manually, it can take a lot of time and effort to update and maintain every month or every quarter.
A company will often further analyze their aging accounts receivable by segmenting the data into “aging buckets” – or how late each customer is in their payment cycle. These are often bucketed into 15- or 30-day increments, such as current, 1-30 days, 31-60 days, 61-90 days, and 90+ days past due. This helps a company more easily understand which accounts to prioritize for collections. Over time, companies can spot trends and understand its “repeat offenders.”
The simple approaches to accounts receivable management outlined above are limited in that they show you the “who” and the “what” of the money owed to your business, but not the “how” and the “why.” How should your company prioritize collections? Why are some of the accounts past due?
Prioritizing collections based on risk, not outstanding amount, can help your company to more successfully collect on receivables. Leverage additional data insights, such as those from a third-party data provider like Dun & Bradstreet, to understand your customers’ business credit scores, trade payment history with other vendors, financial statements, and more. For example, the D&B® Collection Prioritization Score in D&B Finance Analytics Receivables Intelligence predicts the likelihood that a company will change its payment behavior differently next month. A data-driven, risk-based collections prioritization process informs collections staff which accounts are the most or least likely to pay; and it can save your company from time spent trying to collect money you may never receive.
Best Practices & Policies for Accounts Receivable Management
Now that you know how to find out which customers have outstanding receivables, let’s review how a company can go about collecting the owed payments. Practicing a consistent collections policy can help improve collectability.
1. Promptly Send Invoices
2. Make it Easy for Your Customers to Pay You
3. Monitor Slow Paying Accounts
Promptly Send Invoices
First, you’ll want to make sure your company promptly sends invoices and account statements so that your customers know a payment is due. Automated email is critical here. Implementing software that automatically emails your customers well before their due date, and then on their due date, will go a long way in ensuring prompt payment. (Plus it’ll save your team countless hours.) Collections Management from D&B Finance Analytics Receivables Intelligence automates this process with templated emails that include attached account statements and invoices.
Make Payments Easy
If you send an automated email reminding your customer that their payment is due tomorrow, it’s important they have a way to instantly pay you online. Waiting for checks in the mail contributes to reduced cash flow. While many B2B companies still mail paper checks, the trend is shifting to digital payments. The Payment Portal from D&B Finance Analytics Receivables Intelligence is an online portal that enables to you to securely accept, process, and post online payments through ACH/EFT or credit cards.
Monitor Slow Paying Accounts
Despite your best efforts, there will be accounts that pay late or not at all. Keep a close eye on those customers who don’t pay on time. They may have disputed an invoice; you’ll want to clear up any internal issues such as billing errors, price discrepancies, and deductions first. This is another reason where leveraging A/R management software is more efficient and cost effective than manual process. Still, slow paying customers might need more hands-on treatment that includes phone calls, written letters, and involvement with your sales representative. It’s best to try and collect payment yourself before turning over to a third-party collections agency, or written off as bad debt.
KPIs to Track for Accounts Receivable
It’s important to measure the effectiveness of your company’s accounts receivable management efforts. The following metrics are commonly used by A/R teams:
Days Sales Outstanding (DSO)
DSO expresses the average time it takes a firm to convert its accounts receivables to cash. DSO is one of the most often misused and misunderstood performance measures. Its value lies in the ability help determine if a change in A/R is due to a change in sales, or to another factor such as change in selling terms. It is composed of: terms (the future & current receivables), delinquent invoices and operational errors, service and quality problems, disputes, and deductions. (definition provided by The Credit Research Foundation)
Formula: Ending Total Receivables / Number of Days in Period Analyzed ÷ Credit Sales for Period Analyzed
It’s also helpful to compare your company’s DSO to industry averages; Dun & Bradstreet’s Aging A/R and DSO Industry Report, produced in partnership with the Credit Research Foundation, provides these benchmarks.
Collection Effectiveness Index (CEI)
The CEI expresses the effectiveness of collection efforts over time. The closer to 100%, the more effective the collection effort is. It is a measure of the quality of the collection of receivables. Note: CEI can be used as a departmental or individual performance measure. (definition provided by The Credit Research Foundation)
Formula: Beginning Receivables + (Credit Sales/N*) - Ending Total Receivables Beginning Receivables + (Credit Sales/N*) - Ending Current Receivables x 100 *N = Number of Months
Accounts Receivable Turnover Ratio
The Accounts Receivable Turnover Ratio is a formula used in accounting to measure how efficiently a business is extending credit and collecting debt. While it may sound complex, it’s actually quite easy to calculate because it only requires two budget numbers – net credit sales and average accounts receivable.
Formula: Net Credit Sales ÷ Average Accounts Receivable