Managing Accounts Receivable Risk as a Small Business Owner

One of the most critical elements of successfully running a small business is effective cash flow management. Your ability to cover day-to-day expenses and plan ahead for long-term growth hinge on whether you have a steady stream of cash coming in.

How you manage your accounts receivable has a direct impact on your cash flow. Analyzing your accounts receivable, and taking steps to minimize any risk associated with invoicing is essential for maintaining a healthy bottom line.

What Is Accounts Receivable?

Accounts receivable or AR refers to money that’s owed to your business—almost like an “IOU”. When a customer or client makes a purchase from your business but doesn’t pay for it right away, it becomes an account receivable. This is the opposite of accounts payable, which is money your business owes to vendors or service providers.

Accounts receivable are listed as current assets on your balance sheet. Depending on the payment terms you’ve established with your customer, accounts receivable may be due within 15 to 90 days.

Why Accounts Receivable Can Be Risky

Allowing clients or customers to delay payment on invoices can be risky on several levels. Businesses that use accounts receivable are doing so on the premise that their customers are going to be able to pay what they owe. Accounts receivable doesn’t take into account whether the customer has a stable cash flow of their own which will enable them to meet their obligations.

That in turn creates risk for your business because it can affect your profitability, liquidity and cash flow. Assume, for instance, that you have $500,000 in accounts receivable outstanding and half of that is owed by a single client. If that client is another business and they end up filing bankruptcy, that’s a significant amount of money that you can’t necessarily count on. Without those funds on hand, you may have to turn to financing to cover the gap, which could shrink your profit margin.

That’s a worst-case scenario of course but accounts receivable can also pose a threat to your business on a smaller scale. If you’re expecting payment for $10,000 invoice that you need to cover payroll, pay your leasing expenses for the month or keep the lights on and the client doesn’t come through on time, that can disrupt your daily operations and put a pinch in your cash flow.

Having delinquencies in your accounts receivable also makes it more difficult to forecast your future cash flow. Without an accurate idea of when invoices will be paid, it becomes harder to map out plans for investing in your business’s growth. Managing risk in your accounts receivable puts you in a stronger position to be able to carry out those plans according to your time frame, versus when a client is able to pay.

How to Hedge Against Accounts Receivable Risk

The safest way to avoid hitches with your accounts receivable is to simply have customers or clients pay upon delivery for products and services. That, however, isn’t necessarily realistic for every business. Instead, you can hedge against risk by incorporating these best practices into your accounts receivable management routine.

1. Create and enforce a credit policy. When you allow customers or clients to delay payments, you’re effectively acting as a short-term lender so it makes sense to have a safety check in place. Establish a written policy for establishing credit that specifies who qualifies for credit, the terms of credit and the amount of credit you’re willing to extend can make it easier to determine which customers pose the least risk.
2. Be timely about issuing invoices. The payment clock on an invoice doesn’t start ticking until it’s in your customer’s hands so it’s in your business’s best interest to issue invoices as quickly as possible. Aim to send out invoices within 24 to 48 hours of completing the initial transaction so it stays fresh in your customer’s mind. Create a schedule for following up on the status of invoices once they’ve been issued.
3. Outline your payment terms clearly. Having a vague or unclear payment policy can result in delayed payments and increased risk in your accounts receivable. For example, if you don’t specify that you expect payment on a Net 15 or Net 30 basis, your customers may assume they can take their time in getting payments to you. Establish your payment terms and make sure each invoice that goes out to a customer has a set due date.
4. Offer multiple payment methods. Waiting for a client to mail a check, then waiting for that check to clear can be a drag on your cash flow. Opening your payment options up to include credit card payments or same-day ACH transfers can speed up processing times so you’re not waiting as long to get paid.
5. Deal with late payments promptly. Letting late payments linger sends the wrong signal to customers and it could put your business in a financial bind. As you’re drafting your payment terms, be sure to include a clause outlining the penalties for paying late and make sure those are clear to your customers. On the flip side, you could also offer incentives for paying early, such as a 5 to 10 percent discount.

Cash flow is vital to your business’s success and when it comes to your accounts receivable, the last thing you want to do is take a hands-off approach. Being proactive about managing your accounts receivable risk and ensuring that your customers pay on time can keep your business running smoothly.

Samantha Novick is the Social Media Manager at Bond Street, a company transforming small business lending through technology, data and design. They offer term loans of up to $1 million, with interest rates starting at 6%.