Accounting Basics: The Receivables Playbook





Let's talk about accounts receivables. One of the most important components of a business is cash flow. You have to have money coming in so you can pay your vendors. Without an inflow of money a business essentially starves and cannot afford to continue operations for long. Receivables are not a huge consideration for businesses that are paid in cash, but for businesses that bill for their services or products receivables management is a necessity. Equine and agriculture businesses typically fall into this category. I normally try to keep content to a 4 or 5 minute read or video, this one is a little longer, but these concepts are important.


What are Receivables?

A quick break down, receivables are anything owed to you. This can be in the form of payments for services or products, loans, interest, etc. We're going to focus on accounts receivables which are funds owed to you by customers in exchange for a service or product. Receivables are recorded when the work has been done or the goods have been sold. They sit on the books as an asset, they are something of current or future value. On the other hand a client prepaying you for a service or product that you have not delivered on is not considered a receivable. In that case the client has met their obligation in the agreement and you have not. In that case you actually owe the client something, this is considered a liability. This distinction is important if you allow or require clients to pay you before you complete a service or provide them their goods. I'm going to touch on this method of payment because it can be a viable and safer option for some businesses, but it's important to understand that even though you may be sending an invoice it is not a true receivable and will not sit as an asset on your books.


The Reality of Receivables

The reality of receivables is they will most likely not all be collected. You will have clients promise to pay you and then not pay. This is part of doing business, but with appropriate planning and management the amount of receivables you don't collect can be minimized. What does this entail? You need to be managing your receivables before you enter into a business agreement, during the business relationship, and after. We're going to provide you tools for each of these three phases. The important thing to remember is this is an ongoing process which should never stop until the final bill is paid and the business relationship is terminated.


Before the Working Relationship

One thing I always find remarkable about the equine industry is the lack of contracts. I've seen clients end up with people owing them a second payment on a horse and trying to figure out how to collect after they realize there is no proof of the purchase price because they don't like to deal with contracts. Even if it is not the norm in your industry make it the norm for your business. You should have a lawyer draw up contracts for every business agreement where you will be billing an amount that if not collected will hurt your cash flow. I will even argue for any business agreement regardless of amount to reduce your risk. The lawyer's fees in these instances are well worth the expense.


Look at the cash flow of the agreement. If you are incurring a substantial amount of costs in providing a service or products it may make sense to require payment in advance or a deposit/retainer. If you are providing a large number of deliveries of produce, delivered over a lengthy period of time, getting paid once all your deliveries have been made does not make sense. In that case payment on the delivery of each load may make more sense. A large contract may be able to be broken down into smaller components. If you are guaranteeing a certain percentage of your harvest a deposit may make sense. Collecting board at the beginning of the month makes more sense than at the end of the month. Of course you want to make sure your terms are reasonable considering standard industry practices, but these should be lined out before you begin negotiating a contract (if you will even allow negotiating).


Custom terms are something that can be considered to speed up cash flows. This is common when you are dealing with a customer who makes up a large percentage of your revenue and/or who has a lot of purchasing power (because of their influence, purchasing amount, etc they have the ability to negotiate terms where smaller or less influential companies do not have that pull). If industry standards are to require payment in full in 60 days, but you have a client whose immediate payment would benefit your cash flow significantly you can offer them other terms. Something to consider would be a discount if paid within so many days. So a 3% discount if paid in 30 days may provide motivation for them to pay you sooner. What terms make sense in this case? Well it's going to depend on the industry standard and if the benefit of paying early outweighs the benefit of paying later. There is a concept called the time value of money that explains a dollar today is worth more than a dollar in the future. This is because of interest and inflation (more on this concept at the end of this post). So does your discount benefit your client without causing you to incur too much loss of profit?


One more thing to consider before entering into a contract is the risk. If you know a customer is slow pay and the service will require substantial expenses they may not be a client you want to take on if you are having cash flow problems (or even if you're not). Don't ignore the information you have on a client. Extend the ability for clients to purchase on account with well thought out consideration.


During the Working Relationship

You want to stay on top of your receivables during your contracted relationship with a client. If you notice a late payment it may not be necessary to make an issue of the late payment, but make sure you pay attention to the account. If the client is consistently late pay you want to make sure your cash flow can accommodate that account. You may also want to increase your rates to adjust for the delay in payment. If your contract covers interest or late fees for late payments (which many do) you can charge late fees/interest to encourage the client to pay on time. Note that there are often legal limits on the amounts allowed for interest and other fees. Make sure your contract falls under the legal requirements.


Don't stay silent if there is a consistent issue that needs addressed. This does not mean to approach your client in a hostile or aggressive manner, rather have a conversation about their account. You may find they need an adjustment in delivery method or may want to pursue different terms. You won't be able to make adjustments to help remedy the issue if you stay silent. I know discussing an overdue account is often uncomfortable, but remember you cannot help that client get current if you don't open up the conversation. Often times a client may avoid a conversation with you out of embarrassment. We often find a soft and understanding approach works best when approaching a client about a late payment(s).


On the same hand make sure you have been responsive to that client reaching out about any concerns. I have seen people withhold payment when they cannot reach someone any other way. A business relationship is a two way street and it is your job to make sure lines of communication stay open. If you know there is an issue make sure it is addressed.


A helpful report that summarizes your receivables balances is the aged receivables report. This report is typically set up to break down by each client receivables balances that are current, 31 to 60 days past due, 61 to 90 days past due, 91 to 120 days past due, and 120+ days past due. As a general rule if a client has a balance in the 61 to 90 days past due a conversation should be had to make sure you understand any circumstances and to make a plan for repayment. If a client holds a balance past that and will not get on a payment plan or address the issue services and sales for that client stop. Of course these are general rules and lshould be adjusted to reflect your cash flow needs and then adjusted for each client.


A contract can potentially be modified if the needs of the parties change. Some contracts provide an outline for modification. Others may not. Make sure you understand the process allowed by your agreement.


A more obvious, but surprisingly common issue is the fact that clients will probably not pay you if they don't receive a bill. I have seen businesses fail to implement a billing system and their clients be completely unaware they even have an outstanding balance. You have to bill your clients if they are not paying you. Yes we like to think the client knows their board is due on the first, but realistically a client may not pay you because they assume either they don't have a balance or you have a relaxed outlook on their invoices being paid on time.


After the Working Relationship

If you have chosen to end the working relationship or the client has and they still have a balance there are a few things that you can do to help the likelihood of collecting that balance. These include knowing your rights to put a lein on the client's property and potentially setting up a payment agreement with the client. The laws vary from state to state when it comes to stable keepers leins and other leins on the property of a client. This should sometimes be outlined or mentioned in a contract, another reason why having a lawyer put together your contracts is worth it's weight in gold.


However if you find yourself with an unresponsive client who you are no longer doing business with it may be time to consider taking them to court or sending them to collections. This is something that a lawyer can advise you on, the process that is best will vary from state to state and case by case. One thing to consider is if the amount owed eliminates certain methods of collection unfeasible because of associated fees. Because of the likelihood of clients failing to pay after terminating a working relationship with a business I advise my clients to set forth payment terms for final services/goods within their contract. Oftentimes a requirement such as bills being paid in full prior to an animal being removed from the property or a final load of produce being delivered provides an extra incentive for a client to pay. Requirm


Alternate Options

There are other methods of bills collection that we are often asked about. These include things like factoring receivables. When you factor your receivables you essentially sell your receivables to another company. That other company provides you the amount of your receivables less a fee which is often a percentage of the bill based on multiple things. Factoring invoices can provide immediate cash flow relief for businesses. But a word of advice, if the amount you are losing in fees is enough for you to benefit from changing the way you collect so you can keep those fees consider either avoiding factoring invoices or gradually reducing the amount factored.


The Time Value of Money

This is possibly one of the biggest concepts to grasp in accounting that lays down the foundation for a lot of what accountants do. The time value of money essentially states a dollar today is worth more than a dollar in the future. But they're both one dollar right? Yes, but look at it this way, if I have a dollar today I can go invest that dollar in something. That could be something like a savings account with 6% simple interest paid annually. So in a year I have $1.06. If I got that dollar in a year I wouldn't have had a chance to invest it and earn that 6 cents. So my dollar today is going to be worth more than thay dollar in a year. Now take into account other investment opportunities that pay out more than 6% and a higher investment amount than a dollar and you can see why these differences in payment dates matter to businesses. It's also why things like adding late fees, interest, and discounts for early payment work. Because for clients with the wherewithal to pay the benefit of paying now rather than later outweighs the gain from a potential investment over that time period.

614-526-9354

Whitney@MariettiAccountingServices.com

Dublin, OH 43017

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We do not provide assurance services and therefore do not meet the definition of a public accounting firm in the state of Ohio.

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