Collection practices to maximize your cash flow

In a recent article on Cash Management, by the authors, we mentioned that the best time to address how payment is to be remitted by the customer is when the credit limits and terms are agreed. Exceptions can always be arranged but it is helpful to agree on the payment terms up front. This article elaborates on the importance of this and some of the issues that should be addressed in managing the collection process.

A sale is not complete until the receivable is converted to cash. Delays in receiving cash increase the amount of working capital that has to be financed by bank loans or delaying trade payments. Each method has costs such as increased interest expense, loss of cash discount or trade reputation. Unless these additional costs are charged for the profit on the sale will be reduced.

Customer deductions from the amount invoiced can take up a significant amount of a collector’s time and slow down the payment of remaining receivables. Other functional areas of the company can be impacted by the time and effort to resolve deductions. Most deductions are self-inflicted as they are caused by promotional discounts, advertising allowances or represent order processing-billing system problems. Resolving deductions promptly is key to collecting the remaining receivable.

Collection practices can be split into collecting the money, systematic follow up of accounts, customer discussion, and preserving goodwill.

Receivables do not improve with age. The goal is to collect the funds when due under the terms of the sale. The collection responsibility should be assigned to a specific person. This will depend on the account size, transaction volume, frequency and type of deductions among other factors. There should be a written procedure for escalating collection efforts and advising management as receivables age beyond the due date.

There should be a policy specifying how long after the due date the initial collection effort is made. The initial period of time could be as short as a week. The policy should also specify the timing of the second and subsequent follow up calls. The timing between calls, generally 10 to 15 days, will depend on giving the customer enough time to respond to the prior collection efforts, the number of follow ups and the number of people available to take part in the collection efforts. In some situations, such as complex deals and significant amounts, it can be appropriate to call before the due date and confirm that there are no obstacles to the customer paying on time.

Collection systems will probably be determined by the accounting system used to invoice customers and track accounts receivable. These systems can be used to prepare aged receivable reports, account statements, and collection letters. Account statements are widely used as the initial collection effort as they generally give good results and reduce the number of accounts that require additional collection efforts. They are not as effective when the accounts are significantly past due.

Customers who do not pay on time may have business problems. The collector should be prepared to be sympathetic and helpful. The aim of the collection call is to obtain a definite plan to pay the past due items. If they can’t pay the entire amount then a payment plan should be arranged to have a partial payment by a certain date and additional payments at future dates, until the entire overdue balance is paid. The details of the payment plan should be confirmed in writing to the customer.

During the collection process, it is important to be patient and maintain business courtesy. It is desirable to increase the tone of concern and urgency in each successive communication.

A customer who has not paid over a long period of time is one of the following types:

• They have the ability to pay but do not intend to;
• They are unable to pay all their debts and are only paying those who are pressuring them the most; or
• They are unable to pay and will likely be out of business soon.

These customers are in the final collection stage and the idea is to encourage the customer to pay its account and avoid the cost of collecting through third parties such as collection agencies and legal actions. Letters signed by a senior officer outlining the consequences of non-payment and the time remaining until action will be taken are most often used at this point in collection. The main objective may be payment of the account with customer goodwill being secondary. As a result it is often appropriate for the collections staff to involve management, so that delicate relationships are handled appropriately.

A number of companies provide automated collection software which interface with the receivables system and make collectors more productive. These systems create a single electronic interface between the collector and the information required for collections. The system automates the scheduling and logging of collection calls as well as schedules follow-up actions. These systems can also ensure that collection efforts are consistent among collectors and allow for performance comparisons between them. A common result of installing these systems is that collectors call customers earlier and maintain a consistent contact with them.

In the next article in this series on Cash Management, we will discuss how to manage your inventory to improve cash flow.

David Balmer is a Chartered Accountant with over twenty years of Treasury experience with companies such as RJR Nabisco, Cott Corporation and Maple Leaf Foods Inc. He has presented at treasury conferences in Canada and the United States. He has also earned treasury designations from treasury organizations in both the United States and United Kingdom. Contact David at dbalmer@sympatico.ca .

James Phillipson is a Chartered Accountant and a Principal of Mastermind Solutions Inc. www.MastermindSolutions.ca , with over twenty years experience in large and small businesses.  He has provided financial counselling to his clients since 1996, often in the role of or as a coach to a Controller or Chief Financial Officer.  James has experience in financial roles in a wide variety of businesses and industries.  Contact James at James@MastermindSolutions.ca .