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.
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.
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.
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.
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%.