Cash flow is the major artery at the heart of any well-run business, and improving accounts receivable turnover is the key to healthy cash flow management. While cash payments will always be king for many businesses, extending credit is an absolute necessity in today’s produce industry.
There are, however, challenges with credit: debtors. Most are trustworthy and reliable, while some pay late or not at all. In any case, a creditor needs to keep a close eye on all its receivables to ensure payments are made in a timely fashion, enabling the business to pay its own bills while reducing interest payments and decreasing bad debt. The key is to establish procedures to turn accounts receivable (A/R) more quickly, and thus enhance profits.
“By knowing its receivable turnover, a company can recognize issues on credit policies and help improve cash flow,” confirms Luz A. Rodriguez, credit manager for Ayco Farms, Inc. in Pompano Beach, FL. “The formula is very basic: you just take net credit sales of a period and divide by the average accounts receivable for the period. If the ratio is too low, it’s an indication of slow payments and a review of the causes must be completed.”
On the other hand, if the ratio is high, customers are paying fast, cash flow is improving, and there will be ample funds for payroll and pay obligations. But, Rodriguez explains, “if the ratio is too high, this might be an indication that credit policies are too strict and causing stress to customers. Ratios can help you measure how well your credit policies are working,” she adds.
What’s It About?
Accounting functions may not be the most exciting part of a business, but no company can survive without them. While the concept of accounts receivable is rather straightforward—money, often in the form of a credit line, owed to a company by its debtors or clients after delivery of a product or service—when these funds are due is where the risk can come in. Days, weeks, months, or sometimes the inability to collect these variations can make or break a business.
Keeping up with all clients and closely monitoring A/R turnover becomes a measure of financial and operational performance. High A/R turnover usually indicates efficiency and a well-oiled financial operation with tight credit policies, or a business running on a cash basis. Low or declining A/R turnover generally suggests collection problems, or a company in need of reevaluating its credit policies to make sure customers are paying on a timely basis.
Cash Collection Cycle
A key metric for gauging profitability is the A/R cash collection cycle. Put simply, this is the number of days it takes to collect on money owed, or for a sale to convert to cash.
A short cash cycle keeps more cash on hand and reduces a company’s need to borrow; it also reduces the number of older invoices that may prove problematic to collect. Although many produce businesses follow the U.S. Department of Agriculture’s Perishable Agricultural Commodities Act “PACA Prompt” payment terms of 10 days, average pay cycles can stretch to several weeks when invoicing, mailing, and payment methods are factored in.
