Best Practices For Account Receivable Management

Revenue from sales activities serves as one of the essential sources of a business working capital; therefore, the company is required to manage its accounts receivable arising from credit sales effectively.

Every organization requires adequate liquid resources to meet its day-to-day working capital requirement. Companies require cash resources to pay wages and salaries and settle immediate liabilities to ensure smooth and uninterrupted operations. Maintaining adequate cash resources is crucial in the short term to business and a necessity to safeguard the business' existence in the long term, as a profitable company may fail without the adequate cash flow to settle its liabilities as they become due.

What you need to know

For a business to well manage the amount due from customers, its account receivable management processes must encompass the following:

• Assessment of creditworthiness of customer before granting credit sales
• Formulation of credit terms and conditions
• Techniques for receivables collection
• Evaluation of account receivable management 

The above key areas will be explored in more details in this article. 

Assessment of the creditworthiness of customers

To mitigate the risk of bad debt, an entity is expected to assess and measure the financial worthiness of a customer before granting credit, especially when the amount involved is significant. 

Formulation of credit terms and conditions

After assessing the customer's credit worthiness and granting credit to the customer, the company is expected to communicate agreed credit terms and conditions. The credit terms cover the normal credit period, any available discount within certain days of payment, and interest charged on late payments. It is expected that credit terms should vary by type of customer, the relative financial strength of the customer and the type of credit terms other competitors are offering.

Techniques for receivables collection

If payments become overdue, they should be tracked. Procedure for pursuing overdue debts must be established within the company and this could include:

• Sending a monthly statement to the customer – this can be produced quickly and easily by a computerized sales ledger system.
• Chasing payment by making a telephone call.
• Making a personal approach to a senior staff of the company.
• Bill-bill approach may be implemented by the company. These terms require that each prior bill must be settled before new shipments are possible.
• Early settlement discount. An early settlement discount involves a company offering a small percentage discount to customers who pay within a defined short period. For instance, a 1% discount may be offered to those who pay within 10 days from the invoice date.

• Evaluating accounts receivable management

  There are numerous ways of measuring account receivable performance. Most of the techniques measure how effectively outstanding account receivable items can be converted into cash. Performance measures can be derived from general financial reports as well as more detailed internal financial records. The balance of accounts receivable can be monitored using an aged account receivable listing, credit utilization rates as well as reports on the level of bad debt.

  a)     Credit utilization report

  The total credit offered as well as the individual customer account should be monitored to ensure that the company's policy with regards to the total credit limits are maintained. A credit utilization report assists to indicate the extent to which total limits are being utilized.

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