For business owners, prompt customer payments are the cornerstone of your company’s financial health and are crucial for ensuring steady cash flow. These payments are essential in supporting your company’s working capital so unpaid invoices can represent a significant hurdle and challenge to the vitality of the business. Many businesses find themselves without the necessary resources to manage their accounts receivable efficiently, leading to challenges in securing payment on overdue invoices.
If your business is looking to effectively manage your accounts receivable, there are a variety of tactics you can use.
The Role of the Accounts Receivable Aging Report
Past-due invoices don’t get better with age. The longer they age to the right on an accounts receivable aging report, the riskier it becomes and the less likely your business will recover the full value of the accounts receivable eventually leading to a working capital deficit.
An A/R aging report provides management, and other users of the report, with information on several important items, including:
- The identity and history of customers
- The effectiveness of credit terms and collections functions
- Irregularities with the collection process
- Key performance metrics
- Contra-accounts
- Timing of incoming cash flows
- Cash crunch situations
Accounts receivable aging reports must be reviewed weekly by management and collection activity has to be initiated based on the value of the accounts receivable and the days outstanding. Customers with past-due invoices should be notified of their delinquency and all further shipments or services must cease until the past-due receivables are paid in full.
It’s not just past-due invoices that cause issues though. The general lack of accounts receivable management, such as misapplied or non-posted payments, credits, billing errors or adjustments, and balances not written off can wreak havoc with a business’s financial situation. Staying on top of and maintaining a clean accounts receivable aging report is vital as it provides a clear snapshot of outstanding customer debts and their due dates. The report should be reviewed for completeness and checked for errors regularly by reconciling your bank statement to accounts receivable collections.
This transparency is essential for prioritizing collection efforts, identifying past due accounts early, and taking timely action to mitigate financial risks thereby safeguarding the business against cash flow disruptions.
Problems Created by Past Due Invoices and Protracted Payment Delays
- Cash Flow Problems: Past due invoices interrupt cash flow, requiring the use of cash reserves, bank loans or the factoring of your accounts receivable to bridge the working capital gap. The cash used from the aforementioned sources may have been reserved for other purposes – like fueling business growth or research and development, etc. Past due invoices may cause cash flow to be erratic and make it difficult to juggle the demands for cash to meet payroll requirements or pay vendors on time. Most business owners would rather focus on improving and growing their businesses instead of constantly worrying about cash flow problems.
- Management Issues: Having an accounts receivable aging with a high percentage of past due invoices indicates that management is either not tracking key metrics within the organization, not properly vetting the creditworthiness of customers, or not fixing quality issues with the product or services offered to the business’s customers.
- Funding Issues: Past due accounts receivable are typically not eligible as collateral with asset based lenders and accounts receivable factoring companies.
- Reduced Creditworthiness: When cash flow becomes constrained because of A/R collection issues, your accounts payable will typically begin to age to the right as well. When this happens, your vendors who may have better financial controls in place than your company, reduce the amount of credit they will grant your company, further constraining cash flow. Vendors and service providers will take steps to protect themselves when they see these signs. Vendors may reduce your credit limit and/or payment terms. Insurance companies may cancel policies or raise premiums. Landlords may not renew leases or require larger security deposits.
- Friction with Customers: Past due accounts receivable may be caused by poor internal controls. For example a very creditworthy customer may not pay its invoice on time because of problems such as invoice errors, misunderstood payment terms, disputes, and invoices not received. More than 60% of delayed payments are the result of these administrative errors. Past due invoices may also be a result of shipping problems, quality control issues, limited quantities, and pricing discrepancies
Performing regular maintenance on your A/R aging and keeping it clean is essential to the financial and operational health of your business as well as your relations with vendors, professional service providers, and customers. Regular maintenance keeps your A/R aging clean and free of clutter from unresolved disputes, errors, and collection problems.
Cleaning Up Your A/R Aging and Keep It Clean
To clean up your A/R aging and keep it clean you need to eliminate the causes of new problems and resolve existing problems on a timely basis. Some suggestions for accomplishing this include:
- Invoice Automation: Automated invoice processing improves accuracy and reduces errors by eliminating manual data entry and using AI-driven validation and matching. Automation will significantly reduce the number of new problems caused by invoice errors.
- Quickly Resolve Disputes and Billing Errors: Disputes and billing errors are a major source of A/R aging problems. Often businesses don’t become aware of them until an invoice is past due and the customer is contacted for payment. Whether the problem is due to a shipping error, quality issue, or invoice discrepancy, make it a priority to resolve the problem quickly.
- Make It Easy for Customers to Pay: Offering multiple alternatives to pay invoices will accelerate customer payments and keep your A/R aging free of past due accounts. Increasingly, customers do not want to pay using paper checks because of the cost to process and mail, and their accounting processes are automated. Make it easy for them to pay you faster by accepting credit cards, fintech payment processors such as PayPal or Google Pay, ACH, e-checks, and other methods.
- Review Collection Procedures Periodically: Review your collection procedures periodically to make sure they are appropriate for your industry and the current business climate and that they are being followed on a timely basis. Use automated email reminders and frequent calls to let customers know that you follow up for payment.
- Payment Plans: Even the best customers can sometimes get behind on invoice payments. It’s better to be flexible and work with a customer on a payment plan than to get no payment at all and lose future business.
- Promptly Posting Journal Entries: Post payments to the proper invoice and account on the day they are received to maintain system accuracy. Post credits and other adjusting journal entries on a timely basis as well. Reconcile accounts quickly and regularly by following up on unidentified payments. Staying organized and on top of your accounts receivable can help uncover financial errors before they become an issue.
- Collections: Sometimes no matter what you do to help a customer, the best course of action is to pursue collection alternatives. When you make that decision, take action quickly to preserve whatever rights you have, recover as much as possible, and write off balances deemed uncollectible. Do not allow issues to linger as you may end up limiting your rights and remedies for collections.
Actions to consider include: sending Demand Letters, engaging a collection agency, filing liens on projects if applicable (be aware of lien deadlines), filing a blond claim if applicable, and engaging legal counsel and pursuing a legal claim.
The Importance of an Accounts Receivable Aging in the Factoring Process
Staying on top of past due accounts receivable keeps your business financially healthy and helps you identify systemic problems for remedial action. A well-maintained A/R Aging also makes your business a better candidate to qualify for factoring services which can accelerate your cash flow to fuel growth.
Factoring companies, and other commercial lenders, will thoroughly examine your A/R aging report to evaluate the level of risk they are undertaking and therefore it is one of the first pieces of information collected about your business during the due diligence process. An A/R aging that has a significant amount of balances greater than 90+ days aged may be a red flag and signals there are collection/ management issues, your customers are not creditworthy, or there are issues with the products or services you provide.
Cleaning up your A/R aging is very important for invoice factoring as it aids in identifying problem accounts and also directly impacts the factoring terms you will receive. The age and performance of your accounts receivable are used in risk assessment, cash flow analysis, identifying customer credit issues, dilution and continuing due diligence.
Capstone works with clients to provide the working capital funding they need to grow. Call Capstone to learn more about how you can be a better-qualified candidate for invoice factoring.
