Do you have your arms around your cashflow?

Accounts Receivable for Small Businesses

Article written by EricBank

As a small business owner, you need to forecast your cash flow in order to pay your bills, withdraw capital and purchase inventory. One important aspect of cash collection is called terms of sale, which includes the time expected to receive payment, penalties/discounts for late or early payment and a provision for unpaid bills. Most companies extend credit to business customers so that the customers don't have to pay for purchases on the sale date. Accounts receivable (A/R) is where you record and track invoices, credit, payments and balances. Let's take a closer look at some important aspects of A/R.

Terms of Sale

A term of 2/10 net 30 designates that a business customer will get a 2 percent discount if it makes payment within ten days, but that it must make full amount within 30 days. You may charge interest on the balance that the customer hasn't paid within the 30 day window as compensation for delayed collection. You monitor your A/R via aging reports that categorize receivables by the time interval since the original sale. You may decide to use a collection agency to track down accounts that are delinquent for over 90 days. The worst-case scenario is that you'll have to write off the entire invoice.

Because of high collection costs, it's prudent to include a note on your invoice stating that for bills over 90 days past due, the buyer assumes responsibility for collection-related expenses.

The Float

Your business customers maintain accounts payables (A/P), a liability account, to record the credit granted to them and payments due. Float is the amount of interest your customer can earn on unpaid A/P by lending cash instead of using it to pay invoices. Of course, you can earn float too by delaying your payments to suppliers. In our example, the 2/10 net 30 terms mean that the customer can earn 30 days of interest on the amount due before paying the bill. However, there is a cost for doing this: the customer is implicitly paying 2 percent interest for the latter 20 days of the period, which is the discount that the customer forgoes by not paying within the first 10 days. In other words, the first 10 days provide free float to the customer, while the subsequent 20 days has a float cost of 2 percent. Customers with cash flow problems may decide to conserve cash by delaying A/P payments, although they will have to pay implicit or real interest to the creditor -- you.

Factoring A/R

Factors are financial companies that help businesses monetize their A/R. The factor is an agent that purchases your A/R for an agreed cash amount that is always less than the total amount due for collection. The discount price that the factor pays is its source of revenue and a cost to the creditor. This has the effect of replacing A/R with (a smaller amount of) cash on the balance sheet, and you treat the factoring cost as a loss on sale. The amount you receive from the factor might be contingent upon the factor's ability to collect the bills due -- this is called "factoring with recourse." Alternatively, sometimes businesses use A/R as collateral for borrowing.