Debtor management
Include these four key things in your debtor management procedure to help strengthen your cash flow, minimise potential losses, and even eliminate many debt problems before they occur.
Follow up unpaid invoices promptly
Once you’ve got an efficient invoicing system, don’t waste momentum by not following up overdue invoices promptly.
It is all too easy to neglect this task, because few people really enjoy chasing others for money. Here's what should convince you – the longer you leave an unpaid invoice, the less likely your chances of getting paid.
Stick to your terms of payment
There’s no point in setting out terms of payment and then not sticking to them. Tardy payers will soon work out you don't mean what you say and will react accordingly. Be firm but fair.
If people accept your credit terms, then you have a right to expect payment on time, and you are entitled to contact them if this does not happen. Most people are honest and will pay on time.
But for the late payers it's important to get on top of the problem early. Remember the age of the account is critical. It’s wise to review your credit terms to check they still make sense for you.
The advantage of requiring payment within seven days is that you can send out three reminders within the first month.
By contrast, 'payment by the 20th of the month following invoice date' means you might only be aware of a problem up to 50 days after your first sale of goods or services. In the meantime, the customer might have bought more goods or supplies from you, adding to the debt problem.
Review all your credit accounts regularly and contact those who have not paid within the agreed period. A phone call is best, so you can talk to a real person. The earlier you start your credit control, the more relaxed you can make your initial contact.
Cut off credit if necessary
Adopt a consistent 'stop credit' policy of refusing to supply customers who are seriously overdue, and have not responded to your follow-up, e.g. 60 days overdue.
Ask the customer to settle the outstanding debt first before you supply more goods and services. This policy acts as a discipline both for you and the customer and limits any further losses.
Set debt reduction targets
The faster you collect debt, the better your cash flow situation. A great ratio to use is the debtor days ratio, which shows how efficient your business is at collecting debt.
To calculate this ratio, divide the value of your debtors (the money owed to you by customers – you can find this on your balance sheet) by annual credit sales (sales that you’ve issued an invoice for, not cash sales), then multiply by 365 (days in the year).
Debtor days = Value of debtors ÷ Annual credit sale x 365
By regularly calculating your debtor days ratio, you will know how long it’s taking you to collect payments, so you can take action. An answer that’s less than 60 days is acceptable, but it’s a wise idea to set reduction targets. The shorter the average period it takes you to collect payments, the better. For example, if the average age of your debtors’ ledger is 55 days, set a target of reducing this to 40 days.
Your accountant may have a benchmark figure you can use to measure your business against others. For example, if the average for your industry is 40 days but your business takes an average of 47 days to collect debts, your business is less efficient than the industry norm. There’s room for improvement.
How to prepare your financial statements
Learn about the two main financial statements for your business: the Balance Sheet and the Profit and Loss Statement, and how to calculate some key finance ratios like profitability, business efficiency, or business liquidity ratios.
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