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.
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.
And even though payment methods are much more diversified, with online bill-pay services and mobile transfers, other companies use paper checks and the U.S. postal service to complete their business transactions. All of which translates into time, and time is money.
Shortening the cash collection cycle involves a number of common sense approaches from prompt invoicing and phone calls to reminder letters, and if truly necessary, resorting to onsite customer visits, attorney involvement, collection agencies, or turning to industry service providers like Blue Book Services if unable to collect on products sold or services rendered.
How The Pros Do It There are many strategies for improving A/R turnover, but there is no one-size-fits-all solution.
Invoicing, terms, and payment options “To improve average A/R, the company needs to review receivable processes from sales and invoicing to collections,” Rodriguez says. For example, she suggests having a professional-looking invoice and highlighting the invoice number, payment terms, and customer purchase order—and to make sure the customer has agreed to the terms in writing.
“The invoice needs to have accounting contact information on it,” she adds, as some customers get frustrated when they want to process invoices and there is no phone number to call. Of equal importance is mode, and she suggests sending invoices electronically or via email, as well as accepting payment by ACH (automated clearing house) or wire transfer. Creditors can gain five or six days over traditional mail by accepting payments electronically.
Communication and teamwork Keeping in contact with customers is simple yet effective. Josh Prues, credit manager for Scotlynn Commodities, Inc. in Vittoria, ON says the company has “an open line of communication right from start to finish.” Phone calls and emails are the norm, along with biweekly A/R summaries sent to senior management.
Prues says this proactive, customer-facing approach has been successful. “We’ve improved our A/R turnaround and developed stronger relationships with our customers by dealing with problems as they happen.”
Rodriguez concurs. “Customer satisfaction is priority number one; work on having good relationships with your customers,” she stresses. “Making a call to say ‘hi,’ and following up on the status [of an invoice] is always the best approach.” She also believes weekly statements are an essential step, “since you’ll be able to work on any discrepancy a customer might have, and avoid future short payments and delays.”
John J. Jerue Truck Broker, Inc., headquartered in Lakeland, FL, follows much the same pattern. “It’s important to collect our receivables as quickly as possible to prevent having to use a line of credit,” explains Brenda Koon, accounts receivable and payable manager. “Our basic approach is to start calling at 28 days. Our net is 30 days and this gives us an opportunity to ensure all needed documents were received so payment is not delayed.”
If the customer says ‘the check in is in the mail,’ Koon says “we make note of mail date, keep an eye on the customer’s account and, if it’s not received in 7 to 10 days, we call back and approach them a little more aggressively.”
Teamwork and industry tools Having everyone in your company on the same page is also an important part of the A/R process. Accounting personnel should meet frequently with the sales team to update records, discuss clients, and pinpoint potential problems. “If we find a particular customer is being difficult and we’re having trouble collecting, then we’ll have the sales department contact the company’s supply chain person,” Prues says.
Scotlynn also relies heavily on credit tools when setting up new customers or evaluating existing clients. Credit tools like ratings and scores can shed light on days-to-pay trends and how such trends stack up against industry standards. “If we find [customers] trending in a negative direction, we may reconsider keeping them,” Prues says, “or we may not extend a large amount of credit.”
“The best A/R approach is to have an established credit map or credit policy in place,” shares Rodriguez. “Tools such as Blue Book business reports, ratings, and scores can help in making a sound business decision on either increasing or reducing credit limits. We also determine our A/R collections goals based on cash flow needs and periodically set short- and long-term goals,” she adds.
Does size matter? Liquidity and pay do not always correspond to size. Jerue strives to have a 30-day customer base, but Koon comments, “It will never happen. Why? Some of our best customers are 40 to 50-day pay and you can set your watch by them. If they say a check is mailed, it has been mailed. They’re smaller in size and depend on prompt payment themselves and so they treat us the same way,” she says.
It can be a different story with larger customers. “You always have one or more invoices that get filed without being paid, or they’re under a stack of 100 other invoices, or they had a missing number or letter,” Koon comments.
But when the customer is called, she notes, the invoice is found and payment is remitted in a few days, in most cases.
“If a customer gets slower and slower about paying for three years in a row, watch out,” Koon warns. In her experience, it usually means the company is “about to close or be closed due to a shortage of funds.”
Other Tips Offering incentives, such as discounts for early payment of invoices is another tip, as is setting up credit card and online payment methods for the customer’s convenience. By requiring initial deposits, companies can reduce the total amount of credit they need to extend to customers. And, as Rodriguez mentioned, faster billing and invoice generation can help as well.
Better defined credit policies will encourage customers to not delay payments, and increasing the efficiency of collections—some firms use a dedicated team approach—will help speed pay.
Finally, nearly all collections experts agree that companies should discontinue credit to customers who regularly pay their invoices late. By calculating the interest paid on products sold to these late-paying customers, and subtracting it from the profits of those sales, it can be determined if a customer is worth keeping.
Conclusion Tightening A/R turnover is a must for any company, large or small, but for smaller produce companies, it will help ensure continued success. As Prues puts it, “Collecting as quickly as possible helps improve overall cash flow—and in turn allows us to pay our suppliers quicker.”
Rodriguez sums it up by saying, “It is essential to collect receivables quickly to keep the company cash flow goals.” If money is not flowing in, “there might not be enough resources to keep up with company obligations.”
Staying on top of A/R is critical, but also understanding how customers are performing with other vendors is essential, not only for taking appropriate action, but for making more informed decisions as they relate to improving A/R turnover.
Ratings and scores should be reviewed on a regular basis to help with next-step decision making, and Blue Book’s A/R aging reports can be a valuable part of the equation. Comprised of aggregated A/R information shared by industry contributors, the reports reflect current risk, consolidated aging performance, and potential emerging trends. Maintaining a healthy A/R turnover helps protect your business, because cash is always king!
Images: A_KUDR, TeddyandMia, Icon Craft Studio, Anton V. Tokarev & 3RUS/Shutterstock.com
