Entrepreneurs Need to Know Financial Fundamentals

Entrepreneur's Notebook
by Mark Hafner

Many owners of small-to-mid-size businesses are either technicians who have developed their companies' products or salespeople. But running a successful business requires more. It requires paying attention to the financial side an area that some business owners are not at all comfortable. As such, they don't pay much attention until problems arise.

Comfortable or not, business owners must learn how to address the financial dynamics of running a company; they are as critical to a business as sales.

One such example is the management of accounts receivable. The good news is that receivables management is not difficult. It's merely a matter of implementing a good system, and there are only a few basic issues that make up a good system:

- Accurate invoices: It sounds terribly basic, but it's extremely important that invoices are correct. Invoicing errors can wind up costing a company a great deal of money. If one of your customers has cash flow problems, an incorrect invoice provides a customer with an excuse not to pay your invoice. Your customers can come up with enough reasons to delay payment without you helping them out.

- Customized billing cycles: Billing cycles can be set up for any time period, and any sale can trigger a billing cycle. Especially for your larger customers, or on larger ticket items, mailing or delivering an invoice with the finished product can increase the speed with which payment will be made.

Not only can billing cycle start dates be customized, billing cycles can be shortened as well. Offering a discount for early payment can be a strong inducement to pay an invoice, especially for your biggest customers or on higher-priced products.

In addition, learning the billing cycles of your customers can help speed up payment of invoices. If a customer handles payables on the 30th of each month, make sure your invoices are received a few days before instead of a few days after that date so you hit the current payment cycle instead of the next month's cycle. Again, this is very basic and easy to implement, but often times overlooked.

- Credit risk: As your business grows and its investment in receivables grows along with it, it becomes increasingly important to manage credit risk. It's usually in your best interest to have someone with credit expertise analyzing credit issues so that you can concentrate on what you do best, such as sales.

Your credit manager can help you determine credit limits for each customer, how payments should be handled, procedures when credit limits are reached or exceeded, and how to best handle problems so that overall customer relationships will not be adversely affected.

To keep on top of receivables, a report should be done at least once a week. For larger companies, past-due invoices should be reported every day. And rather than running accounts alphabetically, which many businesses tend to do, the report should list accounts in their order of importance. Accounts most important to business owners are those that have the largest dollar amount outstanding due at any one point in time.

- Collection policy: One of the most important elements of an effective receivables management process is the development and implementation of a company collections policy. Typically, collection efforts consist of calling a customer when an invoice is overdue. Obviously this is not viewed as a friendly call, and can often times be the first step towards souring a business relationship.

A better policy might be to tackle collections prior to invoices becoming delinquent. Calling the customer before an invoice is due is much less threatening to the customer than after it's due. Make sure the invoice has been received, that it's accurate, scheduled for payment, and that payment can be expected by a specific date. The call is friendly, the customer is reminded there's an invoice due, and they have committed themselves to an actual payment date.

It's also important to keep in mind that if you want to reduce your company's turnover time, the best way to positively impact turnover is to implement collections before customers are late in their payments.

Obviously, there are always going to be customers who do not pay their invoices on time. You should expect payment delays, especially from your larger customers, and plan for them. But that doesn't mean you should shy away from aggressive collection efforts.

As your company is always going to have some customers who don't pay their debts at all, it's important to institute a bad debt policy. This is achieved by setting up a general ledger account, reserving for bad debts and taking them off your books when appropriate.

- Cash applications, credits and debits: When effective collection procedures bring in timely payments, it's essential that debits and credits are also issued in a timely manner and that cash is applied according to the remittance advice received. Misapplied payments and improperly issued credit (two of the most common mistakes made in receivables records management) serve to increase dilution. Properly maintained records, updated weekly, will reduce dilution.

More effective management of receivables can lead to a steady cash flow stream and increased profits, which is exactly why managing accounts receivable should be a top priority for every business owner.

Mark Hafner is president of Celtic Capital Corp. He can be reached at mhafner@celticcapital.com.

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