Chasing late payments and paying your operating expenses with less cash on hand than you expected to have can be very frustrating – and, unfortunately, a daily reality for many small business owners.
Having more liquid assets on hand better positions you to take advantage of opportunities as they arise, and perhaps even more importantly, gives you peace of mind.
Improving your accounts receivable management is a way to do just that.
Below, we will discuss everything you need to know about accounts receivable, including ways to improve liquidity through savvy accounts receivable management.
What is Accounts Receivable Management?
Accounts receivable management refers to the process of reliably collecting payments from customers.
Good accounts receivable management involves only extending credit to creditworthy customers, sending accurate invoices on time, and staying up to date on payment trends.
Why is Accounts Receivable Management Important for Small Businesses?
Accounts receivable management is important for small businesses because reliably collecting payments from customers leads to improved cash flow and less wasted time for staff.
By managing accounts receivable well, you can decrease the number of late or unpaid invoices – which results in better cash flow.
And your staff won’t have to constantly spend time fixing mistakes on invoices and chasing customers for late payments.
5 Accounts Receivable Management Tips to Improve Liquidity
Let’s look at five ways to improve liquidity through accounts receivable management.
1. Only Extend Credit to Creditworthy Customers
It’s best to only extend credit to a customer if you are confident in their ability to make the payment in the agreed-upon period of time.
You may be wondering:
How do I make this determination?
To start, you can check a customer’s credit score and financial statements.
You might decide to have a rigid process for approval – i.e., a customer needs X, Y, and Z to qualify for credit from our business. But you might want to consider extending credit on a case-by-case basis, particularly if you have a newer small business or each customer has a high lifetime value.
2. Review Your Payment Terms
How fast you get paid largely depends on how fast you ask to get paid. If you are giving customers 120 days to make a payment, it wouldn’t be surprising if many of them opt to pay towards the end of that period (they want to keep cash as long as possible).
The ideal length of your payment terms depends on your industry. If the industry standard is 30 days and you’re giving customers 90 days, you can likely shorten your payment terms to 30 days without much issue.
3. Keep Accurate Customer Data
Keeping accurate customer data allows your small business to consistently send invoices to the right addresses and always know who owes how much.
This data allows you to send clear and accurate invoices immediately and analyze accounts receivable trends (these are our next two tips!).
If you have integrated systems, address changes and payments may automatically be reflected across your systems. But if you don’t, you may have to manually update addresses and payments.
4. Send Clear and Accurate Invoices Immediately
With automated systems, you can efficiently send customer invoices and avoid common issues like entering incorrect amounts, forgetting to send invoices, and sending invoices too late to customers. It’s possible to manually send invoices, but that would likely require a lot of time and effort.
As an added bonus, automated systems save time for your staff – allowing them to focus on higher-value tasks that require the human touch.
Don’t forget to create clear invoices. Upon viewing your invoice, it should immediately be obvious to a customer when the payment is due, how much is due, and how/where to make the payment.
TIP: Send a text message with a payment link that makes it as easy as possible for the customer to pay with their preferred payment method.
5. Regularly Analyze Accounts Receivable Trends
By analyzing your accounts receivable trends, you find problem areas… which might not be too hard to fix.
Here are a few questions to ask yourself:
What characteristics are shared by most of your customers who make late payments… or don’t pay at all?
Do they have a low credit score? A commonality on their financial statements? Or something else?
Are you consistently sending clear and accurate invoices on time?
As mentioned earlier, a big part of good accounts receivable management is immediately sending clear and accurate invoices. But making this a priority isn’t enough – you have to check and see if you are actually consistently sending clear and accurate invoices on time.
Is the liquidity of your accounts receivable getting better or worse?
Consider whether or not your accounts receivables are becoming more or less liquid over time – if the answer is “less liquid,” you might want to make some changes.
A good way to track the liquidity of your accounts receivable is to track the average time it takes your customers to pay their invoices. If the number of days is going up, it means your liquidity is going down.
You may want to encourage faster payments, maybe by sending more frequent payment reminders or incentivizing faster payments with a small discount on the next purchase.
Improve Your Liquidity Through Savvy Accounts Receivable Management
Let’s consider a hypothetical company: Construct, Inc.
Construct, Inc. is a mid-sized construction company specializing in residential and commercial projects valued between $100,000 and $200,000. The company has annual revenue of $5 million.
But they struggle with delayed client payments that impact their cash flow.
On average, clients take 90 days to pay invoices, and Construct, Inc. has experienced late payments from 30% of their clients. Due to this, the company often needs to resort to short-term borrowing or delay their own payments to suppliers, impacting their financial stability.
They implement the following strategies:
- Careful assessment of creditworthiness: Construct, Inc. meticulously evaluates client creditworthiness before taking clients on, targeting clients with strong financial standing.
- Optimized payment terms: Construct, Inc. revises payment terms to 45 days.
- Accurate data management: The adoption of an integrated CRM system guarantees accurate client data and minimizes invoicing errors.
- Automated invoicing: Automating the invoicing process speeds up payments and provides clients with user-friendly online payment options.
- Regular analysis of accounts receivable: Construct, Inc. consistently scrutinizes accounts receivable patterns to identify and address potential issues.
- Discount incentives: A 2% prompt-payment discount is introduced for clients who settle payments within 15 days.
With these strategies, Construct, Inc. experiences notable improvements in its cash flow and liquidity over the course of a year:
- Reduction in Days Sales Outstanding (DSO): With optimized payment terms and improved invoicing processes, Construct, Inc. reduces its average DSO from 90 days to 60 days.
- Decrease in late payments: Due to better credit assessment and improved communication, the percentage of late payments decreases from 30% to 10%.
- Improved cash flow: As a result of faster payments and reduced late payments, Construct, Inc. dramatically improves its cash flow over the course of a year.
Construct, Inc. now has a stronger cash position due to strategic accounts receivable management, which allows them to take advantage of new opportunities, negotiate better terms with suppliers, and maintain financial stability during unforeseen circumstances and slow times.
This positions Construct, Inc. for growth and success in the competitive construction industry.
The Bottom Line
One of the most common issues we see small business owners struggle with is liquidity, and improving it is very important.
Here’s the good news: if you aren’t currently implementing some of the tips in this article, you may be able to quickly improve your liquidity by optimizing your accounts receivable management.
But what if you need cash now?
In that case, consider using Gravity Capital – our working capital program provides quick and easy funding solutions for small businesses.