For accounts receivable teams involved in B2B transactions, managing accounts receivable collections is crucial. In these transactions, businesses often provide credit to customers, allowing deferred payments for goods or services. However, the risk of delayed or non-payment poses a significant challenge to a company’s financial health. Accounts receivable collection is the key focus to mitigate these risks.
The process involves systematically handling outstanding invoices to ensure timely payments from customers. In this article, we will explore what accounts receivable collections involve and delve into best practices tailored to optimize the efforts of collectors and AR teams in their day-to-day operations.
What Is Accounts Receivable Collection?
Accounts receivable collection refers to the process of managing the money owed to a business by its customers for goods or services that have been provided but not yet paid for. It’s a crucial element on the balance sheet, representing the outstanding payments yet to be received. Essentially, it’s the sum of money customers owe to a business for purchases made on credit.
Teams in charge of accounts receivable are responsible for reaching out to customers with outstanding balances. Their tasks include negotiating payment terms and staying in touch with customers who may be behind on payments. In simpler terms, it’s the effort to ensure that the money owed to the company is collected on time.
What is the collection process?
The collections process is a series of steps that businesses follow to manage and recover outstanding payments from customers. Here is a simplified overview of the typical collections process:
- Invoice Issuance: The business provides goods or services to the customer on credit. An invoice is issued, detailing the amount owed, payment terms, and due date.
- Payment Reminder: Before the due date, the AR teams send reminders to the customer, encouraging them to make the payment on time.
- Due Date: The due date arrives, and the customer is expected to make the payment.
- Follow-Up Communication: If the payment is not received by the due date, the collections team initiates contact with the customer. They may send polite reminders or make phone calls to discuss the outstanding payment.
- Negotiation and Resolution: The collections team works with the customer to understand any issues causing the delay. Negotiations may occur regarding payment terms, installment plans, or resolving any disputes.
- Escalation: If initial attempts are unsuccessful, the collections process may escalate. This could involve more assertive communication, involving senior members of the collections team. In extreme cases of non-payment, the business may choose to pursue legal action to recover the debt.
- Payment Receipt: Once the customer makes the payment, the collections team acknowledges receipt and updates the records.
- Documentation: Detailed records of all communications, negotiations, and transactions are maintained for future reference.
Throughout the collection process, effective communication, understanding the customer’s circumstances, and finding mutually agreeable solutions are key components to maintaining positive relationships while ensuring the timely collection of receivables. The goal is to recover outstanding payments while preserving customer relationships whenever possible.
Significance of Accounts Receivable Collections in Business Operations
Collecting accounts receivable is a vital aspect of a company’s operations. It is considered an operating activity because it directly contributes to a company’s cash flow, which is crucial for its day-to-day functioning. Essentially, accounts receivable collections involve getting money from customers who owe the company for goods or services they’ve already received on credit.
When a company successfully collects money from its customers, it enhances its ability to meet financial obligations. However, it’s important to note that just having the money owed doesn’t immediately classify it as income. The company needs to actively collect those funds to consider it part of its operating activities.
In terms of reporting, a company’s accounting department records accounts receivable and collections on its balance sheet. Accounts receivable are initially recorded as revenue with a corresponding expense, and when collections occur, it is treated as an asset, representing the incoming cash. This ensures a clear and accurate representation of the company’s financial position.
How to Measure Accounts Receivable Collections?
Accounts receivable collections can be measured by:
Businesses gauge their accounts receivable collections through the accounts receivable turnover ratio. This ratio assesses how efficiently a business transforms outstanding customer debt into actual payments, indicating its effectiveness in collecting on accounts receivable. A higher ratio signifies the effective conversion of credit sales into cash, while a lower ratio indicates a less efficient collection process.
Another measure is the DSO, reflecting the average days it takes for a business to receive payment for provided products and services. A lower DSO indicates more efficient operations. It represents the average time it takes during the accounting period for accounts receivable to be collected, with the number of days corresponding to the accounting period’s duration.
How Can AR Teams Manage Accounts Receivable Collections?
Effectively managing receivable collections is a crucial responsibility for accounts receivable teams. To efficiently collect money from customers, understanding their needs and meeting them is key. The more you align with customer needs, the higher the likelihood of successful payments for your products or services.
While receivable collections management can be intricate, several business strategies can enhance the efficiency of the process. Implementing strategies like establishing a clear receivable policy, sending payment reminders, and creating well-structured invoices contribute to a smoother collection process. Utilizing customer analytics and automated accounts receivable solutions is a highly effective way to track, collect, and invoice customers. These automated processes ensure that invoices are handled promptly, reducing the risk of uncollected receivables and potential cash flow issues.
What are the Costs of Accounts Receivable Collections in Business?
The process of collecting accounts receivable can be both costly and labor-intensive. Despite these challenges, it’s a necessary investment for maintaining a healthy cash flow in any business. The success of a well-organized and diligent collections process can often determine whether a business thrives or struggles. Consider the following data from D&B:
- A 90-day overdue account has a 69.6% chance of being paid.
- A 180-day overdue account has a 52.1% chance of being paid.
- After one year of delinquency, the chance of collecting payment falls to 22.8%.
While resorting to collections agencies is typically a last option, businesses may turn to them to recover debts. However, these services come at a significant cost, ranging from 25% to 45% of the total amount owed. The company only receives payment if it successfully recovers the outstanding debt.
7 Ways to Improve Accounts Receivable Collections
Smart Data Utilization
In today’s digital age, data stands out as the most valuable asset. It’s crucial to have comprehensive customer data, covering payment statuses, trends, and financial health for successful payment collection. Accurate customer information not only facilitates effective communication but also prevents confusion or the spread of incorrect details.
Embracing technology can help centralize customer data into a single source of truth. This approach allows easy access to individual customer records, and you can use filters based on payment status, purchase details, etc. when reaching out to them for payment collections.
Flexible Payment Terms
To avoid payment issues with customers facing financial difficulties, consider adjusting payment terms based on their circumstances. For instance, extending the payment period from Net30 to Net45 or exploring partial payments could be helpful.
The objective is to facilitate timely payments without straining customer relationships. Pressuring financially stressed customers to pay the full amount immediately may lead to delinquency and is not in the best interest of the business.
Sending out invoices on time is crucial for effective receivable collections. This process is closely connected with other accounts receivable functions, such as invoicing and cash application. To speed up collections, it’s essential to send customers their invoices as soon as possible. Additionally, accuracy is key; errors in invoices can lead to delays in collections. To further expedite the process, consider including payment links within the invoices. This simple addition can significantly contribute to faster and more efficient accounts receivable collections.
Proactive Payment Reminders
Many invoices are delayed simply because customers unintentionally overlook due dates. Utilizing effective strategies such as sending reminder emails can significantly help customers remember their payment responsibilities on time.
To streamline this process, consider employing a reminder automation solution. This tool can automatically send reminders to clients at predetermined intervals, such as a week before the invoice is due or 1-3 days before the due date through multiple channels.
Depending on the nature of your relationship with the customer, industry norms, and geographical factors, you may also choose to make a collection call for a friendly reminder. Moreover, using dunning emails that include embedded payment links has proven to be a more effective method in successfully collecting accounts receivables.
Pursue Late Payments
Ensuring overdue payments are promptly addressed is crucial for managing outstanding invoices and boosting cash flow. By consistently communicating with customers and sending reminders, businesses emphasize the importance of meeting payment commitments.
Proactive follow-up on overdue payments showcases professionalism and a commitment to financial stability. These effective strategies help nurture positive customer relationships and minimize the occurrence of unpaid invoices.
Customer Experience Management
It’s crucial to highlight that these processes should never involve the use of threatening language when communicating with customers.
Instead, AR teams need to possess the skill of empathetic communication and engage in courteous conversations with clients. Understanding the reasons behind payment challenges, such as cash flow limitations, banking issues, or product-related concerns, allows for the cultivation of positive customer relationships.
Simultaneously, AR teams should address firmly those customers providing unreasonable excuses. Even in these situations, it’s important to avoid damaging relationships or harming business reputation.
Adapt Automated Solutions
Embracing automation is crucial for making your accounts receivable collections process more efficient. By using accounts receivable automation software, AR teams can digitize and centralize their collection efforts. This means they can send accurate and timely invoices, automate reminders and notifications, and effectively manage credit risk.
This approach improves teamwork and simplifies everyday tasks like preparing invoices and generating reports. Automation also ensures consistency, freeing up the AR team from repetitive tasks and allowing them to focus on building strong customer relationships and analyzing customer behavior.
Automated solutions prove to be the most efficient method for ensuring compliance, especially as the traditional process of paying paper invoices can be time-consuming. Customers often face the hassle of locating the invoice, writing a check, and sending it via mail.
Peakflo’s Accounts Receivable automation solution eliminates these steps, allowing customers to conveniently settle invoices from anywhere anytime, eliminating the waiting time for mail delivery or trips to the bank. The solution establishes an optimal accounts receivable management system for your business.
With this solution, AR teams can:
- Create and send professional e-invoices, including tax, GST, recurring, and pro forma invoices, in seconds
- Set up reminders based on customer aging buckets
- Send multi-channel manual or automated payment reminders
- Track internal and external communication trails, capturing follow-ups, messages, questions, bounced messages, and open rates
- Escalate to the right stakeholders in the customer’s organization.
- Record promise-to-pay dates and amounts to simplify collections.
- Access all relevant customer data in one place
- Access pending tasks through a personalized “Actions” tab.