Small Business Advice
In order to measure collections of accounts receivable, there are two standard measures. The first is an “aging schedule” which just lists the amount that is owed within certain time periods. This might say that $100,000 of receivables are less than 30 days old and $200,000 are 30 to 60 days old and $100,000 is over 60 days. With this aging schedule you can see over time how effective your collection effort is.
Another benchmark for measuring collections of accounts receivable is the ratio called, average collection period. This ratio just specifies the number of days of credit sales tied up in accounts receivable. The formula is just accounts receivable divided by credit sales per day. If I have terms of net 30 days and my average collection period is at 45 days then it says that I am not doing an effective collection effort.
Some of the things that you can do to improve collections is to make sure that someone is in charge of this activity. Like most things, if no one is in charge, it tends to slip between the cracks. Additionally, you need to make this a top priority of yours and remind staff how important this is to the business.
Now making collections calls and asking for money is no fun and many folks do not like to do this. However, this must be done and you doing some of these calls sets the right tone for your business.
Some firms have moved successfully to the policy that the bill is due upon receipt rather than having terms like net 30 days. This due on receipt really does speed the cash coming in.
Another thing that you need to consider is credit terms to encourage customers to pay early. For example you can offer terms of 1/10 net 30 which means if you pay with 10 days, you can take 1% off the bill but the full amount is due by day 30.
Charging a fee of 1.5% for late payment is another thing that you can do to speed up collections. However, if someone does not have the money to pay, this seems not to have a great impact.
Finally, you need to have a collections policy in place. It should specify what will happen as the lateness of the bill increases. For example a collection policy might state: a. if a bill is 15 days past due then a duplicate invoice with a nice note saying the invoice might have gotten lost. b. if a bill is 30 days past due, then a call is made checking on the status of payment and finally, c. a demand letter goes out and says if payment is not made, the bill will be turned over to a collection attorney and no further goods or services will be provided to the customer.
Jerry Osteryoung is the Director of Outreach of the Jim Moran Institute for Global Entrepreneurship in the College of Business at Florida State University, the Jim Moran Professor of Entrepreneurship; and Professor of Finance. He was the founding Executive Director of the Jim Moran Institute and served in that position from 1995 through 2008. He can be reached by e-mail at firstname.lastname@example.org or by phone at 850-644-3372.