Credit sales are a fact of business life. An important skill that Maine-based small business owners develop is maintaining the balance between the total cost of bad debts and profit gains.
As a small business owner, you need to constantly monitor your total receivables and bad debts. Part of the process involves weighing the benefits of making more sales against the costs of collection and interest on current receivables.
If the total cost of bad debt is more than the profit gains from increased sales, it’s time to take action. The hard part is that in many cases, you must match the credit terms and policies of competitors to help foster sales. This is a difficult part of finding the balance, but it must be done.
There are three critical tools that can help small business owners stay in control and measure collection activity:
Receivables should be held for the shortest time possible. This pumps up the timeliness of payments and maximizes the rate at which you are collecting bills during a given period. Divide net credit sales by average accounts receivable to determine the ratio.
This gives you a clear view of your receivables and their due dates, for a simple understanding of your collection efforts and highlighting of overdue bills. This tool typically includes the name of the creditor, the total due, and the amounts due in the current month, the previous month, the preceding two months and more than 60 days.
Average Collection Period
For the small business owner, one of the most important measurements is the average number of days it takes to collect a bill. This is the length of time it takes to convert sales into cash and highlights the relationship between accounts receivable and cash flow.
The longer the collection period, the more you invest in accounts receivable, equaling less cash available for the business’ own needs.
The average collection period is used to analyze your collection efforts across various time periods, and determine how well your customers are doing paying their bills when compared with your credit terms. It is also used to see how your business is doing with account receivable management, as compared to other companies in your industry.
These are just some of the tools that let you track your company’s success at controlling accounts receivables. Filler & Associates can help you use these tools as well as other ratios, reports and measurements to keep a handle on credit customers.