Fractional and Interim CFOs are often called upon to make an immediate financial impact at small and mid-sized companies. As in most cases, they often face specific challenges in managing their client’s Accounts Receivable (AR) assets. While larger organizations have access to sophisticated tools, these smaller and midsized companies frequently operate without the advanced systems needed to optimize cash flow and reduce bad debt. A lack of big-budget AR automation tools doesn’t mean their receivables performance must suffer. With the right tools, much can be done to help these companies quickly improve their Receivables performance. Below are our recommendations to quickly analyze the health of the Receivables asset for a measurable impact.
1. Measure and Evaluate Customer Payment Trends
Understanding customer payment behavior is crucial for managing trade receivables. It’s not enough to simply compare Days Sales Outstanding (DSO), as it can be skewed by sales volume. Instead, compare how close to or far from the terms customers are paying.
| Measure | 2024-08 | 2024-07 | 2024-06 | 2024-05 | 2024-04 | 2024-03 | 2024-02 | 2024-01 |
|---|---|---|---|---|---|---|---|---|
| Days Sales Outstanding (DSO) | 26 | 26 | 25 | 27 | 27 | 28 | 34 | 36 |
| Best Possible DSO | 18 | 19 | 19 | 20 | 19 | 21 | 24 | 26 |
| Days over Best | 8 | 7 | 6 | 7 | 8 | 7 | 10 | 10 |
In this example, customers are paying 10 days faster in August than in January. This improvement is due to an eight-day reduction in terms (Best Possible DSO) and a two-day improvement in payment speed (Days Over Best). The portfolio improvement results from 80% terms reduction and 20% reduced delinquency over the past seven months. In this scenario, we recommend continuing the current strategy to achieve optimal performance.
2. Assess Top Customer Credit Exposures
Evaluate the credit exposures of the company’s 20 largest customers to assess bad debt risk. Check public records for any signs of financial distress, such as liens, judgments, or UCC filings, in order to proactively prevent losses. Monitoring customers’ cash flow performance is key to detecting early signs of financial difficulty. If a customer does not provide financial statements, consider contacting their bank references to inquire about cash availability and track changes over time.
3. Identify Process Gaps
Look for gaps in the company’s credit and collections processes. For example, if the company does not consistently obtain credit applications, it may limit its ability to enforce terms and conditions, collect what is due, and understand the risk of extending credit to a customer. If there is confusion regarding role definitions between Sales, Customer Service, Accounts Receivable, and Collections, it may be necessary to clarify roles and responsibilities. Clear documentation is essential, covering everything from customer setup and credit approval to billing and collections. Process gaps can lead to unnecessary bad debts and delinquencies.
4. Review Staff Fit for Receivables Management
Ensuring the AR team is appropriately skilled for the portfolio’s characteristics is important and critical to success. If the receivables portfolio is diversified without large concentrations of risk, a team focused primarily on collections may suffice. However, if there are significant balances concentrated among a few customers, it is crucial to have team members skilled in credit analysis. Rarely does one person excel in billing, cash application, credit analysis, and collections. While small companies may need generalists, as a business grows, it should aim to build a team of specialized experts to manage receivables effectively. Hiring generalists to “do it all” may result in missed signs of potential bad debt and slow payment situations.
5. Evaluate Existing Automation
Assess the capabilities of the company’s ERP and collection software to ensure they can handle transaction volume and provide necessary reports. If the ERP or collection system does not generate key reports, like payment trends, consider upgrading to more advanced automation tools. If AR team members primarily use spreadsheets rather than databases for their work, it may be time to invest in dedicated collection software. Additionally, if customers require vendors to manage receivables through vendor portals, ensure these processes are automated with bots to handle invoice processing, disputes, and cash flow expectations. Proper monitoring is critical to maintaining a healthy trade receivables asset.
Conclusion
Maximizing your clients’ AR performance starts with the right strategy and expertise. Implementing these five strategies can significantly improve their trade receivables outcomes. For deeper strategic guidance expertise, contact The Credit Department, Inc. (TCD). We offer expert consulting, outsourcing, advanced AR reporting, and AR automation services designed to deliver measurable results.
Since 1993, TCD has helped businesses worldwide identify and solve inefficiencies in their credit departments. Our hybrid automated software and AR expertise provide solutions that are designed to quickly enhance critical AR processes by reducing DSO, identifying portfolio risks, mitigating customer disputes, and automating to improve cash flow and reduce costs. Reach out at info@tcd.com or call 651-451-0164.
