Although not as glamorous a financial term as net profit or gross revenue, accounts receivable deserve your attention.
Managing them efficiently is the critical step in turning money you’re owed into actual cash that you can use to both run and grow your small business.
Small business owners and accountants who stay on top of their accounts receivable reduce bad debts, improve cash flow, and make better business decisions.
We’ll cover these benefits and more in detail in this article.
- Support Cash Flow
- Improve Decision Making
- Eliminate or Reduce Bad Debt
- Help Avoid Unclaimed Property
- Facilitate Staying On Top of Your Taxes
- Appeal to Venture Capitalists
Support Cash Flow
Effective accounts receivable management is critical for turning accounting money—unpaid invoices and the like—into real, usable cash, which you can use to do all sorts of great things to improve your business.
Here are some ideas on what you can do.
What to Do With Extra Cash?
|Go Bargain Hunting||If there is software or equipment that’s lower-priced than usual, use your funds to grab this product at a bargain.|
|Eliminate any Debts||Pay down your debt, reduce the overall interest you’ll pay, and improve your company’s debt-equity ratio.|
|Create a Rainy Day Fund||Save some cash for months or years where business slows down and you do run into cash flow troubles.|
|Reward Your Employees||Consider giving out a bonus to top-tier employees who you want to incentivize and retain.|
Failing to ensure your accounts receivable function is efficient can lead to cash flow issues and cash shortages.
These cash flow issues can have serious consequences for a small business. According to a study by U.S. Bank, 82% of small businesses fail due to poor cash flow management practices or a poor understanding of how cash flow affects their business.
This failure occurs when cash flow gets bad enough that businesses become unable to pay vendors and employees or fund other functions that help them earn revenue.
For instance, if a contractor has no available cash to buy paint or pay their painters because money is tied up in unpaid invoices, they can’t accept the job, and revenue takes a hit.
A summer camp with no cash on hand might fail to pay the electric bills that keep the lights on, and have to end operations.
To avoid cash flow problems, businesses should use cash flow statements (CFS). They factor in financial information, including accounts receivable, to create cash flow projections.
Below is an example of the kind of data you’ll find on a CFS:
After creating a CFS, you’ll have insight into your current and future liquidity, and therefore be able to plan your expenditures more wisely. This financial awareness is crucial for the success of your small business.
Improve Decision Making
With lots of money on the line, business decisions shouldn’t be taken lightly. Business owners should follow a strict process to ensure they avoid misjudgments and end up on the right path.
Below is an example of such a process:
As you’ll note, step number two deals with gathering information. For many investment decisions, collecting accounts receivable data will be part of this step as it will help you predict cash flow.
When you manage your accounts receivable effectively, you’ll be able to get this data more easily and then review it in order to form a clear picture of your current financial situation.
The clarity enables you to then make sound strategic investment decisions.
For example, you’ll know when it’s financially appropriate to grow your workforce, expand to new offices, or purchase new equipment or software that adds value to your business.
Plus, as we mentioned in the previous section, since efficient accounts receivable management leads directly to better cash flow, you’ll have a greater ability to make these investments as soon as opportunities arise.
If you find a bargain on a piece of equipment, you can buy it right away and reap the rewards.
If, however, your accounts receivable management process is inefficient, you may have too much money tied up in unpaid invoices, and therefore won’t be able to seize the opportunities that you’ve decided would be beneficial to your business.
You may suffer a high opportunity cost:
For a simplistic example of opportunity cost, imagine if you had to wait a month to invest in a software solution that would give you a return of $10,000 per month because your money was tied up in unpaid invoices.
In that case, your opportunity cost would equal $10,000.
In other words, it would be your return on investing ($10,000) – return on not investing ($0).
Additionally, tight management of accounts receivable enables you to make smart decisions about future extensions of credit.
For example, a business might find that its smaller clients are often late on payments.
They can then decide to stop extending credit to future customers with fewer than a certain number of employees.
Overall, quality fiscal organization and management will give you the best intel and data you need to make decisions that grow and improve your business.
Eliminate or Reduce Bad Debt
When accounts receivable is deemed uncollectable, it’s written off as a bad debt. It means that you’ve rendered a service or delivered a product and will receive nothing from it.
There’s plenty of room for improvement in AR management and collection processes.
Aside from damaging your faith in humanity and losing money, incurring enough bad debts can put you behind your estimated cash on hand during a given period, meaning you might run into cash flow issues because you’ve spent what you intended to receive.
To avoid this situation, monitor your accounts receivable and stay on the lookout for payments that are well past their due date.
The longer past the due date payment is, the likelier it is to turn from a doubtful debt to the less fun, bad debt:
Over time, as you track AR, you’ll start to notice which customers are failing to pay their bills or are notoriously late, and you can bar them from receiving future services until they’ve made good on their obligations.
Or, if their payment issues are pernicious enough, stop working with them altogether. These practices can help you prevent future bad debts.
And, when you reduce bad debt, you directly improve your business’s profit and have better cash flow to run operations and make smart investments.
Help Avoid Unclaimed Property
It’s important that the department that manages your accounts receivable also has an understanding of unclaimed property, as they will likely end up having oversight of it, since the two are connected.
According to unclaimed property specialist Joshua Moldrup:
“Accounts receivables become an unclaimed property issue when credit balances occur that go unresolved and age beyond the respective dormancy period (typically 3 to 5 years).”
Here are some common types of unclaimed property to illustrate this point:
Source: RKL CPA
For example, an unclaimed property could arise from a refund you’ve made that has not been retrieved by the customer after three years.
Companies are obligated to report unclaimed properties like this to the state in which the customer resides, in order to maintain compliance and avoid audits and penalties.
Unclaimed property often results from customer credit balances.
And these can occur from some of the following instances:
- when a business adjusts an invoice to be lower than the amount the customer paid
- when a business offers a refund for a product that the customer has returned
- when a customer has overpaid for a service and is credited the difference
If you track your AR, it’s easier to spot customer credit balances and address them by either reaching out to the customer or reporting it to the state yourself.
The overall goal, however, should be to create an accounts receivable management process that is so efficient that it precludes credit balances from ever remaining on the books long enough to become unclaimed property.
A big step towards building such a management process is to implement a software solution, such as Regpack’s recurring payment system which will give you a clear overview of your AR situation.
It will even enable you to schedule dunning emails and payment reminders that should help you collect money more efficiently.
When accounts receivable professionals follow credit balance best practices like following up with customers regularly and adding credit balances to invoices, you’ll reduce the time balances stay on the books and all but eliminate any unclaimed property risk.
Facilitate Staying On Top of Your Taxes
Small business owners often find tax-related tasks to be stressful and overly time-consuming.
In fact, 40% cite bookkeeping and taxes as the worst part of owning a small business.
And, according to the same Score study, 40% of small business owners spend over 80 hours on tax preparation a year.
But, taxes don’t have to be such a headache—as long as you stay organized, that is.
For instance, if you diligently track your accounts receivable, taxes will be easier to handle for you, your accounting team, or your CPA.
Now, the way AR affects your tax payment process depends on your business and how your taxes are calculated. Knowing the difference is important.
If you’re a cash basis taxpayer, accounts receivable will be taxed as ordinary income.
If, on the other hand, you’re calculating your taxes using the accrual basis, you won’t pay taxes on the portion of the purchase price connected to AR.
Regardless of how you calculate taxes, if you monitor your AR, you’ll have a better understanding of how much money you owe in taxes. As a result, you’ll reduce any stress leading up to tax filing.
And when the taxman calls, you’ll know what to do.
Appeal to Venture Capitalists
In 2021, global venture capital funds reached a record high of $268.7 billion, according to Refinitiv’s data cited by Reuters.
Venture capitalists are looking for strong startups to invest in.
If you want to attract investments from these venture capitalists, it’s important to track and record your accounts receivable.
That’s because investors will ask you for documentation to support what you’ve pitched to them in an initial meeting.
They’ll look at accounting data like your AR and AR turnover ratio to forecast your profitability 2-5 years into the future.
If you’ve been successfully tracking and managing your accounts receivable and collecting payments from customers in a timely manner, investors won’t hold a high AR against your business.
They’ll instead likely give points to your business for its efficient collections process.
This is a positive reflection of your finance and accounting team, and, according to Nexea, startup investors consider team quality one of the four most important criteria when deciding to invest:
Furthermore, in order to make a sound investment, investors won’t just look at your collections stats in a vacuum.
They’ll typically compare your account receivables to industry averages in your target market. However, if you’ve been doing your AR management effectively, there’s no need to worry about this.
But, if during their research, investors get any indication that your business struggles to collect what it’s owed and has unreliable customers, they might become hesitant to invest in your company.
For example, if they find too many accounts over 60 days or more past due or a large number of clients who consistently pay late, they might shy away from a partnership.
AR issues like the above signal to them potential cash flow problems, which, according to startup expert Purity Muriuki, is one of the main reasons investors decide to opt-out.
“Cash flows showcase the startup’s financial soundness. Therefore, an entrepreneur should exhibit its company’s financial true picture. Investors are veterans and have the capacity or expertise to identify entrepreneurs that have manipulated figures or acting like pompous business owners.”
In other words, investors are able to tell whether you’ve had long-term success at collections, or if you just cleaned up your AR at the last minute.
The latter doesn’t reflect well on you, as it indicates you still have those root issues that will just cause more late or missed payments in the future.
Venture capitalists do their due diligence. They want to ensure that the business they’re investing in has a strong accounting department that gets its money and can keep cash flow high.
If you can show them you have these qualities, you’re one step closer to receiving that money to grow your small business.
Creating an efficient accounts receivable management system will help your business make better decisions, avoid unclaimed property risk, attract and close investors, and more.
If you want to improve your AR and collections process, check out our article on how to track accounts receivable, where we explain how to implement practices like establishing billing procedures and using automated billing.