Mike was running a successful business with good cash flows and it was going all well until many of his customers defaulted payments in large numbers something he wasn't prepared for. Mike had to borrow funds to meet operational expenses which increased the cost of doing business thus putting his business at risk.
What could have caused the accounts receivable challenges for Mike? Let's do a case study.
"Mike wasn't enforcing his customers to pay within the payments terms and was ok with delayed payment".
Most businesses offer services on a credit basis where an invoice is raised on a specific milestone and customers pay these invoices on agreed timelines. Businesses and customers will typically have mutually agreed to timelines to make the payment also called Net D.
For example, Net 30 indicates that the net invoice amount is expected to be paid in full within 30 days of the Invoice Issue date. Net 10, Net 15, Net 30, and Net 60 are some of the common payment terms in practice.
"Mike wasn't monitoring cash flows and related statistics, He wasn't noticing that his month-on-month Days Sales Outstanding (DSO) kept increasing."
Many businesses miss the insights from the account receivable data that provides early warning signals. Some of these insights can provide views on business-level cash flows while others can also be derived at the individual customer level.
Below are some of the metrics that need to be monitored, and measured to ensure corrective actions can be taken upfront.
DSO is about how quickly money is collected after an invoice is issued. A healthy DSO does not exceed your terms by half for example if the payment term is Net 30, then a healthy DSO is 45 Days
Best Possible DSO considers only current accounts receivable and not past data. It indicates what your on-time payment turnaround is going to be.
Average Days Delinquent (ADD) is a metric that lets companies know the average number of days those late payments take to get collected. The lower your ADD score, the better.
Your accounts receivables turnover ratio or Debtor turnover ratio shows how well you manage the credit you extend to your clients and how efficient you are at collecting payments. The higher the ratio the better.
CEI helps to understand how strong your accounts receivable management is. The closer the CEI is to 100%, the better your processes.
"Mike was following up with the point of contact from customers on an ad-hoc basis and more of informal reminder, he was using offline follow-up techniques like emails"
Following an ineffective communication strategy and doing informal communication will give the customers the view that the receiving organization is fine with delays. Moreover, most of the time the follow-up happens with the same person and doesn't follow the escalation route when the same doesn't give the expected outcome.
"Mike had a team of 3 people working on the accounts receivable process and each of them was capturing AR information locally. There was no single place to audit the conversation, commitments, and next planned actions. The same became a people-centric process."
Businesses lose control of account receivables if they are not able to track them centrally or audit the communications happening with the customers. Typically businesses follow up via several mediums like emails, letters, calls, and SMS. The follow-up information is split across several devices and calls are not recorded/transcribed thus making it difficult to audit or use as evidence for any legal proceedings.
"Mike was not driving the customers to provide a Promise date for making payments and not tracking closely whether the customer had made the payments as per the promise"
One of the common mistakes that a business makes is that they don't drive the conversation with customers to provide a promised date by which the payments will be made. More damage happens when there is no follow-up or tracking to check whether the customer kept the promise by making the payment.
"Mike had provided bank deposits as the only means of payment and that became challenging, especially during lockdowns. He didn't offer any incentives or discounts as well for on-time payments"
Customers have their own preferred payment channels, and enforcing limited payment options will have a negative impact on their payments. Also, customers typically tend to pay towards the end of payment terms as they can hold liquidity till that time and there is no benefit to making early payments.
"Mike's customers have several Invoices/bills to be paid, and the same is shared via emails and letters. Customers typically respond to queries or requests via email most of the time and that can be quite time-consuming"
Interactions in the accounts receivable process typically occur through emails and letters which are discrete by nature. Customers need to refer to multiple email threads or physical letters to get details of their overdue. This can be tedious as well and the same goes for responding to these emails as well.
"Some of Mike's customers had raised disputes on incorrect Invoices and also on the quality of services rendered and he wasn't able to handle them properly."
Customers typically will hold the payments till the disputes are resolved or corrected. Disputes can also worsen the relationship with the customers, bringing in friction and making it much more difficult to collect payments leading to bad debts or credit risks.
"Mike was providing services to customers irrespective of the repeated payment delays, with increased AR delinquency levels."
Customers belonging to various industry sectors have different levels of risks involved, for example, the Logistics and Hospitality sector impact due to the pandemic, etc. Lack of credit scoring at the customer level will increase exposure to bad debt and put businesses at a bigger risk.
"Mike was not updating the payments received in the banking books against the accounts receivable process on a regular basis."
The lack of a real-time payment interface and reconciliation with the accounts receivable process will cause an incorrect dunning process, resulting in an unpleasant experience for customers.
Tackling all these challenges can get overwhelming and tedious for anyone, that's why it's best to invest in accounts receivable automation software for your business.
Start automating your accounts receivable process right away with our Accounts Receivable Automation Software - Maxyfi, and watch your business thrive!
For more tips on how to tackle the challenges in your accounts receivable process, follow our Maxyfi blogs.