Detecting Problems

A successful credit and collection policy requires that all problems be detected and acted on as early as possible. The sooner a problem is detected, the sooner it can be corrected. This is particularly critical in receivables management where the sheer passage of time can aggravate any problem that may exist.

An important indicator of the effectiveness of your credit and collection policy is your average collection period. The average collection period is a ratio that expresses the total amount of receivables outstanding in terms of an equivalent number of average daily credit sales.

Figuring the Average Collection Period

The average collection period is calculated as follows:

Accounts Receivable
_____________________

Average Daily Credit Sales

Or, viewed another way, the total amount owed by customers is equivalent to 45 days' credit sales, on the average.

For example, if a business had average monthly credit sales of $6,000 and outstanding accounts receivable of $9,000, the collection period would be calculated as follows: 

This indicates that, on the average, customers are taking 45 days to pay their accounts. (Some formulas for calculating the average collection period consider only net credit sales. These are determined by subtracting an estimated allowance for bad debts from total annual credit sales. While the result is mathematically more precise, it is being ignored here and the simpler formula, based upon total credit sales, is being used for instructional purposes.)

Comparisons

The average collection period can be compared with any of the following bases to determine whether or not a problem exists:

Payment terms. If your terms of sale specify payment within 30 days and your average collection period is greater than this, it indicates that creditors are not complying With your terms and a problem exists.

Past history. Comparison with your experience in previous periods indicates whether or not collections are improving or declining.

Industry averages. Comparison with the experience of other companies in your industry will determine whether or not your credit and collection policies are as effective as those of your competitors. (Industry averages are usually available at your library or trade association.)

Determining the Extent of the Problem

The extent of the receivables' excess can be measured by comparing your actual receivables with a target level. For example, assume that your terms of sale specify payment Within 30 days, and your industry average collection period is approximately 30 days: A suitable target for your receivables Would then be 30 days' average credit sales.

If your average daily credit sales are $200, you could then calculate a target for receivables as follows:

Average daily Sales x Collection Period = Receivables

$200 x 30 = $6,000

If your actual receivables were $9,000, you would then know that you had an average of $3,000 ($9,000 - $6,000) in receivables that require attention.

Corrective Action

A relatively high average collection period indicates that a problem exists and corrective action must be taken. Prompt attention should reduce the collection period, speed con­version of receivables to cash, minimize your capital tied up in accounts receivable and, at the same time, reduce the risk of uncollectible accounts.

Aging of Receivables

Analysis of your average collection period will help you identify and measure receivables problems in total. However, immediate corrective action requires identification of individual problem accounts.

Problems in individual accounts can be detected through analysis of your receivables by aging. A receivables aging divides each customer's account into amounts that are 0-30 days old, 31-60 days old, 61-90 days old, etc.

The longer an account is past due, the more serious the problem. These can be identified quickly by aging, and corrective action can be initiated promptly.

For example, examine the receivables aging below. The first account shown, L. Brown, has a total outstanding of $775.02. Of this amount, $317.91 is 0-30 days old, $222.63 is 31-60 days old, $156.32 is 61-90 days old, and $78.16 is over 90 days old. Some prompt action seems required.

Totals are entered for each age group. It is often useful to calculate the percentage of total receivables in each age group to alert you whenever overdue receivables become excessive. For example, if you knew from past experience, or from industry averages, that receivables more than 90 days past due were sel­dom more than 5% of total receivables, the 19.9% would instantly alert you to a dangerous situation that requires immediate correction before you are faced with possible serious losses.

Internal Collection Procedures

The fundamental rule of sound receivables management is to minimize the time span between the sale and collection. Any delays that lengthen this span cause receivables to build to unnecessarily high levels and increase the risk of uncollectible accounts. This is just as true for delays caused by your billing and collection procedures as it is for delays caused by the customer.

Invoices

Proper collection procedures begin with invoice preparation. Invoices should be prepared promptly and accurately. Prompt­ness eliminates one possible source of delay. Accuracy prevents those delays that occur when the customer disputes the invoice and returns it for correction, triggering a chain of events that is time-consuming and often costly.

Invoices should clearly state payment terms. Is payment due within 10 days? Thirty days? Are the days measured from the receipt of goods? Receipt of invoice? End of the month?

Cash Discounts

When selling to large accounts such as commercial, industrial, institutional, and governmental buyers, collection is often accelerated by the offer of a cash discount. The discount, usually 1% or 2%, is offered for payment within 10 days. Most large organizations take advantage of all such discounts. In so doing, they can sharply reduce your commitment of capital to accounts receivable. If your competitor offers cash discounts, it may be necessary for you to include the same provision to maintain your competitive position.

Specifying Payment Terms

Payment terms normally include discount terms and dating terms. Discount terms describe the discount available, if any, for prompt payment. Dating terms specify the time when payment is due.

Discount terms are usually described as follows: 2/10

The number before the / is the discount percentage, in this case 2%. The number following the / is the number of days within which payment must be made in order to take advantage of the discount. In the example, the customer can take a 2% discount for payment within 10 days.

Evaluate your budget occasionally with actual operations figures. With effective records you can accomplish this. Then, where
discrepancies show up it is possible to take corrective actions before it's too late. The right decisions for the ideal corrective
action will depend upon your knowledge of management techniques in buying, pricing, selling, selecting and training personnel, and
tackling other management problems.

You're thinking you can hire a bookkeeper or a Accountant to deal with the record keeping for you. Yes, you can. But remember two
very important details:

1. Supply the accountant with accurate input. If you buy something And don't record the sum in your business checkbook, the
accountant can't enter it. Should you sell something for cash and don't record it, the accountant won't know about it. The records
the accountant prepares will be no greater than the info that you provide.

2. Use the documents to make conclusions. If you moved to a physician And he told you you were ill and needed certain medicine to
get well, you'd follow his advice. Should you pay an accountant and he tells you your sales are down this year, don't hide your
head in the sand and pretend that the problem will go off. It won't.

Business Management Roll in Personnel Selection. If your business Will be big enough to require external assistance, an important
responsibility will be the choice and coaching of one or more employees. You may start out with relatives or business partners to
help you. But when the company grows - as you hope it will - that the time will come when you must select and train employees.

Careful selection of personnel is essential. To select the right Employees decide beforehand what you need each one to perform.

Then search for applicants to fulfill these particular needs. In a small Business you will need flexible employees who can shift
from task to task as needed. Include this in the outline of those tasks you wish to fill. At precisely the same time, look ahead
and plan your hiring to assure an organization of people capable of performing every essential role. In a retail store, a
salesperson might also do stock-keeping or accounting at the start, but as the business grows you will need sales people,
stock-keepers and bookkeepers.

When the project descriptions are composed, line up applicants from whom To make a choice. Do not be swayed by customers who might
suggest relatives. In the event the candidate does not succeed, you might lose a client as well as an employee. Some sources of
possible new employees are:

1. Tips by friends, business acquaintances. 2. Employment agencies. 3. Placement agencies of high schools, business schools, and
colleges. 4. Trade and industrial associations. 5. Help-wanted ads in neighborhood papers.

Your next job is to screen want ad answers or program Forms sent by employment agencies. Some applicants will be removed sight
unseen. For every one of those others, the application form or letter will act as a basis for the interview that ought to be
conducted in private. Put the applicant at ease by describing your business generally and the occupation particularly. As soon as
you have completed this, encourage the applicant to talk. Selecting the proper person is extremely important. Ask your questions
carefully to learn everything about the applicant that's pertinent to this job.

References are crucial, and should be assessed prior to making a final decision. Check through a personal visit or a phone call
directly to the applicant's immediate former manager, whenever at all possible. Verify that the information given you is correct.
Consider, with judgment, any negative remarks you hear and what isn't said.

Checking references can bring to light important information Which may help save you money and potential annoyance.

Personnel Training. A well-selected employee is only a possible Asset to your business. Whether he or she becomes a true advantage
depends upon your own training. Recall:

To allow adequate time for instruction. Not to expect too much from The trainee in too brief a time. To let the worker learn by
doing under real working conditions, together with close oversight. To follow along with your training.

Examine the employee's operation after he or she was at work For a time. Re-explain key points and short cuts; bring the employee
current on new developments and invite questions. Training is an ongoing process which becomes excruciating supervision.

Personnel Supervision. Supervision is the next crucial of personnel control. Good oversight will reduce the expense of operating
your business by cutting back on the amount of employee errors. When errors are corrected early, employees will find more
satisfaction out of their jobs and perform better.

Motivating Employees. Small businesses sometimes face particular Problems in motivating employees. In a large business, a
Fantastic employee can see An chance to advance into management. In a small business, you are the management. One thing you Might
Wish to Think about is to give great workers a Small share of the profits, either through part-ownership or even a profit-sharing
plan. Somebody Who has a"share of this activity" will be more Worried about helping to make a success of the business.

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