Avoid Falling Into These 7 AR Management Traps
How to Maintain Balance and Focus on Accounts Receivable Outcomes
As a small business owner or executive, managing accounts receivable (AR) and navigating through various credit decisions is an integral part of the job. After all, credit and collections is essential to the performance of your order-to-cash (O2C) process and cash conversion cycle. From processing credit applications to negotiating payment plans, each AR activity you undertake requires thoughtful consideration. Unfortunately, many of these skills are not something you are likely to learn in business school. You may pick up some of the theory there, but the practical details of managing an AR portfolio are seldom, if ever, addressed in an academic setting.
Commercial credit and collections, the management of trade receivables, involves skills most people learn on the job. The professional associations that serve the business credit community, as well as this newsletter and other publications, supplement that hands-on experience with training tools, reference materials, and certification programs. There is a lot to be learned in terms of the legal and regulatory environment, banking, communication, process management, and even export perspectives.
Please feel free to share this newsletter with your small business customers . . . it just might help them pay you sooner!
Given the hustle and bustle of managing a small business, it's absolutely crucial to get AR management right. Avoiding common mistakes and continuously enhancing your decision-making skills in regard to AR processes will help you stay on the right track.
Continue reading to learn about seven AR pitfalls that you should avoid, including:
Relying on Outdated Information
Creating an Imbalance Between Risks and Rewards
Failing to Prioritize Effectively
Relying on Band Aids Instead of Addressing Root Causes
Seven AR Pitfalls
1. Depending on Outdated Information
In today's fast-paced commerce environment, customer situations can change rapidly. Avoid relying on outdated credit financial statements, references, or credit reports. Dun & Bradstreet reports that there are demographic changes to 20 percent of their file every year, and that doesn’t include changes in payment patterns. Regularly update information in your credit files so you can make informed decisions when customers make requests such as credit line increases or term extensions.
2. Creating an Imbalance Between Risks and Rewards
While it's prudent to be conservative in financial matters, avoid letting it drift into excessive risk aversion. Effective credit management involves managing risk, not avoiding it entirely. Consider creating a risk pool for prospective accounts that are elevated credit risks. Set a limit on the pool, incentivizing the sales department to ensure timely payments from these risky accounts in order to create room for additional sales. By the same token, many organizations focus on sales without considering credit risk. That’s a sure path to increasing past due balances and ultimately bad debt losses. For most companies, credit policy should fall somewhere in the middle. A key factor in determining that will be your gross margins. They higher they are the more risk you can take in order to optimize profitability.
3. Failing to Prioritize Effectively
Because collections is a numbers game, you need to focus on impactful tasks rather than spending a lot of time checking off low-priority items. Prioritize collection activities based on their significance (usually dollars past due), working from the top down. Addressing important tasks ensures that you make a meaningful impact and avoid falling behind due to the completion of less critical activities. Credit approval (new accounts and orders) always needs to be a top priority, but approving new orders is also made easier by keeping up with your collections. Use the 80/20 rule to focus your collection calls on the 20 percents of customers that account for 80 percent of your revenue and then rely on a high volume of dunning notices to less significant customers.
4. Relying on Band Aids Instead of Addressing Root Causes
While temporary solutions may provide quick relief, it's essential to address the root causes of issues in your O2C process. No matter how well thought out your order acquisition and fulfillment processes, there will be problems that keep recurring. Often these items cause invoice discrepancies which in turn cause payment friction with your customers. Identify system weaknesses and eliminate band-aid solutions, such as manual workarounds. Fixing root causes once and for all ensures long-term efficiency, facilitates cash flow and minimizes future problems.
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5. Avoiding Tunnel Vision
Amidst your daily workflows, it's easy to get lost in the details. Regularly step back to assess your entire workload and accounts receivable portfolio. Don’t lose sight of the forest for the trees. Failing to do so can hinder your ability to prioritize activities and identify emerging trends. Portfolio monitoring and analysis is crucial for optimal accounts receivable performance. If you don’t have a grasp on your risk exposure, you cannot proactively address it. If you aren’t picking up on developing risk trends, you will constantly be putting out fires and risk getting blindsided.
6. Sweating the Details
Although the saying "don't worry about the small stuff" has its merits emotionally and intellectually, it's crucial to recognize that "the devil is in the details." Taking shortcuts, especially with things like logging collection calls or reviewing new customer applications, may seem time-saving initially but can lead to oversights and more work in the long run. Thoroughness in dealing with details is essential for a robust credit and collections management process. But, as we noted in the previous section, don’t get lost in the details. Instead, make sure you are managing them.
7. Not Managing Your Ego
Guard against letting ego interfere with decision-making. It's easy to recognize this fault in others, but it's important to acknowledge it within oneself. Resist the temptation to dismiss recommendations from others based on personal biases. Decisions should be based on the best interests of the business, not influenced by personal feelings or conflicts. It’s human nature to want to give more slack to the longstanding customer who has come upon hard times, but doing so may not be an acceptable risk. Conversely, it is only natural to want to say no to the customer that is always making demands, but if they purchase in quantity on good margins, maybe they deserve the extra attention. Bottom line, don’t let hubris cloud your decision-making.
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In Retrospect . . .
As a small business owner or executive, navigating the complexities of AR management is critical for ensuring the efficiency of your O2C process and maintaining a healthy cash conversion cycle. Successfully managing AR involves addressing various challenges, and the pitfalls discussed highlight the importance of strategic decision-making in this domain.
The seven traps outlined above provide valuable insights for anybody with AR responsibilities and illustrate the need to continually enhance decision-making skills, stay updated with industry trends, and strike a balance between risk mitigation and business growth. Getting AR management right is indispensable for sustained business success, and the lessons illustrated with these pitfalls can significantly contribute to achieving that goal.