The essentials of working capital management (2)

One of the goals for a business is to make profit from selling its products or provision of services. The company has the choice of providing its products and services on either cash basis, credit basis or both. Profits will only come from cash sales. Credit sales have the risk of turning into bad debts in the near future and become a business expense.

However, not all products or services can be provided on a cash basis. In this regards, the company has to include both a cash and credit element into the sale process. For example, the terms of the sale could be: 10% cash deposit paid upfront and 90% balance paid by instalments. The 90% balance form what are known as receivables or debtors. Receivables are amounts owed to the business by its customers, whether or not they are currently due. They also form part of the current assets in the company’s balance sheet.

Effective handling of receivables is essential for effective working capital management. Having too high a value of debtors on the company balance sheet is definitely a recipe for disaster. Remember, cash is needed for everyday transaction purposes, to take advantage of new investment opportunities and to maintain a safety cushion to meet unexpected cash needs. If the majority of sales are on a credit basis, then this creates uncertainty. The company cannot accurately predict its cash inflows and outflows hence cannot competitively plan ahead.

Although receivables form part of the current assets which need to be greater than the current liabilities for a favourable working capital position, it is highly advisable that your cash in hand and at bank exceed the value of your debtors.

The process of managing receivables (debtors) involves one or more of the following:

# Don’t feel guilty asking for your money: Don’t be too nice to your customers to the extent that they take advantage of you and start delaying making payments. This is especially so with small businesses where some of your customers might be close friends. As the old saying goes: Don’t mix business with pleasure. However, make sure that you are preserving your customer relationships and not jeopardising them.

# Have a system in place that tracks and pursues late payers: This involves compiling a debtors ageing schedule. You need to continuously monitor your debtors and assess the likelihood of them defaulting. Be honest to yourself. If chances are high that some of your debtors are likely to default, write the debts off before its too late and start planning ahead. Don’t plan ahead for an investment based on amounts that you are unlikely to collect.

Once in a while remind your debtors (via email, letter or telephone) of their outstanding debts and if need be agree a repayment plan with them even if it means offering them an early payment discount. It is better to receive something than nothing.

# Use external help: If you realise that you are not making any progress recovering outstanding debts, why not solicit the help of external debt collectors. For a fee, debt collectors will help you recover all or part of the debt. By outsourcing your receivables management process to an external company, this will also help you focus on other important parts of your business.

# Implement E-Invoicing: By automating your invoice-generation process, it helps you generate payments faster than say, creating an invoice, post it to the customer and wait for them to respond. Also, by automation, you could set up your system to inform you that the invoice has been received and read. This helps avoid situations where some customers claim non-receipt of invoice because the invoice was lost or delayed in post. Another way would be faxing the invoice to the customer followed up by a telephone call to confirm receipt.

How else can a company manage its receivables (debtors)?

Comments and questions are welcome.

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