Quite simply, accounts receivable is money owed to your business by a customer (a debtor) who purchased either goods or services on credit and will be paid in the short term. While accounts receivable are listed as an asset as far as accounting goes, a business does not have access to these funds until they collect on them. As a result, a company that has most of its assets in receivables, does not have access to very much working capital and may suffer from poor cash flow.
Most commonly, a receivable is money owed by a customer in exchange for goods or services performed. A receivable is represented by an invoice that becomes payable at the end of the agreed upon terms. Usually the terms of an invoice are for 30 days, but it is not uncommon to see terms that are 45 days, 60 days, 90 days, or longer. It is also possible that the terms may allow for payments to be made in installments. A subscription is also another form of a receivable.
Accounts payable is the opposite of accounts receivable, it is money that you owe to another company. Therefore, your account receivable are your customer’s accounts payable. Where accounts receivable is considered an asset, accounts payable is considered a liability.
In order to convert accounts receivable into cash, you will have to collect on the receivables. Alternatively, there are ways to receive funding based on receivables. Since receivables are an asset, banks are willing to consider them as collateral when giving a loan, but will typically value them at only 70-80% of their actual value. However, you will still need to collect on your receivables in order to pay off the bank loan. Another alternative is accounts receivable factoring, where you sell your receivables to another business (a factor) at a discount. In this scenario, since your factor is purchasing your receivables, you are no longer responsible for collecting on them, and unlike a bank loan, there is nothing to pay back. Your factoring company will also fund you the same day you invoice your customer, greatly improving your cash flow.
It is quite possible that a customer will not pay you on a receivable. This could be due to a customer filing for bankruptcy or going out of business, in which case there is little you can do to collect on the receivable. If a customer is simply a deadbeat who isn’t paying their bills, you could hand over your receivable to a collection agency. Collection agencies work on contingency and in general take between 25%-33% of what they collect as a fee. In the event that you are unable to collect, or have to give a portion of your receivable to a collection agency, then you will have to write this off as bad debt.
The most important thing you can do to avoid writing off bad debt is to check out your customer’s credit prior to offering them payment terms. If a company has poor or no credit, you may ask them to pay upfront for goods or services. There are two main ways to credit check a company. First, you can subscribe to a credit agency and pull reports on companies. This is the best source of credit data available, but depending on which agency you use, they may or may not have data on your customers and you will either need to subscribe to their service on an annual basis or pay for each report, regardless of the quality of the reports they provide. The other option is to ask your customers for credit references and then ask their references to provide you information. It is important to note that when doing this, a bank is not a valid reference, you will want to focus on trade references from companies that are similar to your own. However, these references are not required to provide you with any data, and oftentimes will not respond to credit reference requests. Should you receive a response, you also need to be sure that the credit reference is a valid one, some dishonest businesses will provide reference sheets with contact information for family and friends who will provide them fake references.
The other option is credit insurance, which can be obtained in two different ways. The first option is credit insurance companies. Just like any other insurance product, you pay a premium for credit insurance and there will be deductibles, minimums, and maximums. In general, if you do more volume, and have higher quality customers, then insurance companies will offer you a better rate on your premiums. For companies who do under a million in sales annually, getting credit insurance can be very expensive, and oftentimes due to deductibles and minimums won’t cover any of your losses. Insurance companies will handle credit checking for you, but typically only on larger accounts, for smaller accounts that won’t meet deductibles they will not provide any credit checking. As a result, you will still have to perform credit checks on smaller customers. The other way to get credit insurance is through a factor that offers non-recourse factoring. Factoring companies do not charge premiums, and do not have deductibles, minimums, or maximums, instead the insurance is included as part of the factoring. Factoring companies will provide credit checking on all of your accounts, regardless of size, so you will no longer be responsible for credit checking.
There are many reasons to offer credit terms to your customers. First and foremost is that your customer may require it. If you wish to sell to a large company who is requesting 90 days to pay, your option is either to agree to their terms or forgo the sale. With smaller customers, they may not require credit terms, however they will be much more likely to place larger orders if credit terms are offered to them. Getting credit terms will allow them to collect on their receivables before their payables become due, so by getting terms they will have access to more funds at the time that their payables become due. Offering terms can also lead to quicker reorders as your customers won’t need to worry about having the funds available when they want to place a reorder. Finally, if you don’t offer credit terms, then your customer may find a competitor who does and place their order with them instead. Therefore, offering credit terms is a very important sales tool, even if it means you will be holding onto receivables instead of cash.
Managing your receivables can be difficult, especially for new or growing businesses. At DSA Factors we have been providing accounts receivable factoring for 35 years. Let us manage your accounts receivable by performing your credit checking and collection work for you. In addition to that, we will fund you the same day you invoice, providing you with much improved cash flow, and will fully insure your receivables with our non-recourse factoring. Give us a call today at 773-248-9000, email us at email@example.com, or chat with us right here on our website.