Doesn’t it just give you the @?%&s when you’ve delivered a great job or product and customers don’t pay you on time?
Unfortunately customers don’t always do the right thing, so you need to factor this into your business management.
One of the most important factors relating to getting paid on time, is measuring the number of days customers are taking to pay you. This is quite different to the credit terms you give them and sometimes vastly different!
Accounts Receivable Days
This is the result of a formula calculating the average number of days it takes customers to pay from date of invoice until you receive payment.
Accounts Receivable Days = Accounts Receivable/Revenue x Time Period
Accounts Receivable = $150,000
Revenue = $800,000
Time Period = 365 days
150,000/800,000×365 = 51
This example indicates that a business with Revenue of $800,000 and Accounts Receivable of $150,000 is taking, on average, 51 days to collect payment from its customers. This is very different to the actual terms offered to customers, which might be say 30 days. Reality is that very few customers actually pay on time.
The value of knowing the Accounts Receivable Days Driver of 51, is that the business now has a simple indicator to work with and use as a starting point to measure improvement.
If the business could get the Accounts Receivable Days Driver down, that would put thousands of dollars back into the bank account.
Depending on the profitability of the business this could cover month’s of overheads. Imagine how much better the business owner would feel having an extra month’s overheads in the bank!
Another benefit of knowing this number as opposed to just looking at the dollar value of amounts owed by customers, is that it’s a relative figure. E.g. using the above example if the Accounts Receivable rises to $250,000 is this good or bad?
It depends on the relative Revenue figure. This makes it immediately more difficult to manage. Whereas tracking one number is an easy indicator to manage, both for the business owner and the accountant or bookkeeper.
Importantly, if this is a growing business wanting to fund growth through external debt i.e. borrowings, any lender would look very closely at this number. It’s a prime indicator of how well the business manages its own money and therefore how it would manage the lender’s funds.
Many businesses grow rapidly and get very focused on Revenue growth. This is fine, but focus also needs to be on collecting payment for sales made.
If not, cash-flow can quickly get squeezed, which can strangle any hope of continued business growth. It becomes a vicious circle, as a lender won’t lend the necessary funds until the business demonstrates it has firm control over its cash-flow.
Managing Accounts Receivable Days
It really boils down to making sure you get paid as quickly as possible. A retail business doesn’t have this type of problem, as it gets paid immediately, however most other businesses give ‘customer credit terms’.