IN OUR EXPERIENCE, one of the easiest cash holes to plug in a business is too much customer credit, extended for too long a time period. That’s usually a pretty quick solution. We call it “dialing for dollars.” Just get on the phone and start collecting.
The harder thing to fix is the mindset that created the situation in the first place. Sometimes it’s a family issue, as some of our clients tell us that their credit customers are a legacy from their father or mothers’ ownership. But more often, it’s a reluctance to lose a sale from someone who can’t plunk down cash or a credit card. Let’s see if a little math can inspire you to change your ways. (Or at least get you to pick up that phone faster.)
For example, if your high-profit peers take 105 days (an average Accounts Receivables Turn of 3.47 turns per year) to collect money from their customers, and you wait 169 days (an average Accounts Receivables Turn of 2.15 turns per year), those 64 days can really take a bite out of cash flow.
If we know the formula for accounts receivable turnover, which is the rate at which customer debts are collected on an annual basis, we can use these numbers to find out what your receivables “should” have been if you managed your collections process as well as your high-profit peers:
If we know that Accounts Receivable Turnover equals Credit Sales divided by Accounts Receivable, then we can re-arrange the formula like this: A/R = Credit Sales ÷ A/R Turnover
Then, to figure out where you want to be (which is at the same level as the high performers) add the word “Target” to both sides of the equation: Target A/R = Credit Sales ÷ Target A/R Turnover
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So, let’s say your 2005 sales were $3,000,000 and that 25% of your sales were made on credit. We can then divide your credit sales by the high-profit group’s Accounts Receivable Turnover number (the target) to get your target accounts receivable.
Target A/R = $750,000 (CREDIT SALES) ÷ 3.47 (TARGET TURNS)
Target A/R = $216,138
But your actual unpaid accounts at year-end were more like $350,000. So the difference between your Actual Accounts Receiveable and your Target Accounts Receivable leaves you with an Excess Accounts Receivable of $133,862.
[inset side=right]That’s the money you would have had if you had sent those reminder notices, gotten on the phone, and been more proactive in doing collections.[/inset]That’s the money you would have had if you had sent those reminder notices, gotten on the phone, and been more proactive in doing collections.
When you take the almost $134,000 in excess accounts receivable and divide it by 64 days (the difference by days in collection speed between you and your high-profit peers), you get close to $2,000 for every day you let your customers keep your cash. Think of all the ways you could have used that cash. Could you have taken some supplier discounts? Bought more of those fast-turning items? Maybe. More cash always means more choices. But you’ll never find out if you don’t make some changes, pronto.
Start by getting weekly aging reports. It’s just a single page, with five columns:
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Customer Name/ Current/ Over 30/ Over 60/ Over 90 Days
Jump on the ones in the last column first, then work your way in. Make sending weekly statements out a priority. Get invoices out immediately. Get that money!
This story is from the May 2006 edition of INSTORE.
