How Are Your Accounts Receivable Performing?
Tracking Customer Payment Performance in a Turbulent Economic Environment
The threat of bad debt loss and diminished cash flow from delayed payments increases significantly when the economy is volatile or during a recession. The reason is simple — many of your customers will be suffering lower sales volumes, discounted pricing, delayed payments, higher costs, supply chain issues, or a combination thereof. The result is their own profitability and cash flow shortages.
This inevitably results in your firm experiencing reduced cash flow from collections (your primary source of cash) and an increased risk of never being paid. If the cumulative impact of both these eventualities, slower payments and more defaults, is of sufficient size, your company could face insolvency. The simple truth of the matter is that cash flow problems are the primary cause of bankruptcies.
At this time, the onset of trade wars and the devaluation of the dollar, on top of lingering inflation, is increasing the likelihood of recession. We are also dealing with elevated interest rates and a dearth of traditional bank lending to small businesses. As a result, the cost of borrowing for your customers remains elevated, causing them to rely on trade credit for liquidity, which translates into paying their suppliers beyond terms.
It is much less expensive for your customers to extend payments 15, 30, 60, or even 90 days as opposed to borrowing funds to facilitate on-time payments. In times like these, many customers have historically relied on their suppliers to be a last resort in terms of funding working capital.
Solving the Dilemma
Identifying problematic customers and accounts early is essential to prevent escalating issues that could jeopardize your business’s financial stability. Deteriorating payment performance by individual customers or a broader decline across your accounts receivable (AR) portfolio can lead to increased past-due balances, reduced cash inflows, and heightened default risks.
By closely monitoring key metrics—such as overdue balances, customer payment trends, and AR aging reports—you can proactively address these challenges. This enables you to focus collection efforts on high-risk accounts, adjust credit policies, and implement more aggressive collection strategies when necessary. Timely detection and action not only safeguard your revenue but also ensure your organization remains agile in responding to financial challenges.
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Action Plan Guidelines
In order to stay ahead of the curve, you need to understand both how individual customers are faring as well as the overall impact on your AR portfolio. This requires you to detect:
Individual customers whose financial condition and payment performance is deteriorating, resulting in higher past due AR, a decrease in incoming cash flow, and an increased risk of default.
The aggregate performance of your total AR portfolio in order to measure the cumulative severity of payment deterioration and default risks.
If there is a substantial deterioration in the payment performance of a relatively few accounts:
Focus your collection efforts and senior management attention on the larger accounts to reduce the risk to your firm
Refer the smaller accounts to a Collection Agency after trying one last time to collect — in most cases, if a month has gone by and payment has not been forthcoming, send a final demand letter and let your Collection Agency take it from there.
If there is a substantial deterioration in the payment performance of a large number of customers:
Overhaul your entire collection effort to be more aggressive by increasing the number of customer contacts and shortening the interval between your follow-up activities. This may require adding a collector or two, even if just as a temporary employee. If you are being more aggressive with your collection strategy, that should also translate into placing delinquent accounts (especially smaller ones) with a Collection Agency sooner than under the old policy.
Evaluate the cost/benefit of insuring, outsourcing, or factoring your AR—When credit and collections are not a core competency of your firm, there can be substantial benefits to turning the work over to an outfit that has the expertise and automation tools to handle the assignment more efficiently.
Essential Metrics and Their Reporting Frequency
You can’t manage what you don’t measure. Too often, organizations only look at AR performance after the end of the month. Tracking monthly DSO trends does not cut it when you are faced with a potential crisis, such as a recession, and may need to change tactics mid-month. Here are some guidelines for effective AR monitoring:
Daily
Cash Receipts are easily determined on your bank portal from the daily bank deposit. This can be obtained in no time at all from your bank’s portal and easily plotted in a graph so you can monitor trends.
Weekly
Cash receipts for the week—recorded and charted to provide visual trends
Total AR—from your AR Ledger
AR over 30 days past due and over 90 days past due—This should be tracked by total dollars as well as a percentage of total AR and can be derived from your AR Ledger. The AR that is over 30 days past due is the AR that should have already been paid and which is becoming less collectible every day. The over 90-day past due AR is in real danger of not being paid. Increases in over 30 and over 90-day past due balances indicate an increasing likelihood of future bad debt losses.
Monthly
The three weekly metrics—Listed above
Unapplied Cash—This is a “housekeeping” metric. Unapplied cash consists of customer payments that have not been applied to open invoices. It is caused by missing, incomplete, or unclear remittance advice (instructions from the customer as to which open invoices they are paying). Unapplied Cash can be applied by simply contacting the customer for instructions, but of course, this takes time. The danger with unapplied cash is that customer invoices will appear open (unpaid) when, in fact, they have been paid. Unnecessary collection contacts will be made, which annoys customers and wastes your time. Worse, you may receive an order from the customer on credit hold pending payment of items you think are still past due. It’s essential that the level of unapplied cash not exceed 2-3 percent of total AR. Anything above that level will affect your collection efforts.
AR in Dispute—Hopefully, this metric can be generated by your AR Ledger system or a separate Dispute/Complaint/Issues log. Typically, this is done by simply entering a dispute code that can then be easily tracked. Otherwise, an open dispute log will have to be constructed by your collector(s) or personnel who deal with customer complaints. Amounts in dispute are in serious jeopardy of:
Being paid late (a virtual certainty)
Never being paid
Being paid for a lot less than the invoice amount.
Even worse, the collectability of disputes decreases rapidly over time. You must have visibility into the magnitude and age of disputed invoices to avoid a potentially large loss. Usually, disputes increase in a recession. Customers dispute invoices to delay payments as well as report legitimate issues with orders fulfilled.
Average Days to Pay—The ability to track this for individual customers, if you can, is extremely beneficial. First and foremost, it allows you to see each individual customer’s payment trend. Anybody slowing down is a problem. Sometimes, though, the trend isn’t the story. A customer’s payments may become erratic but still maintain their average. This is a red flag that they are having cash flow problems. If you are able to calculate the average days to pay, you should also be able to calculate the standard deviation. When that starts increasing, the customer is becoming more erratic with their payments, signaling that it is time for you to take action.
Some Final Thoughts . . .
Tracking and reporting metrics consumes time and effort. However, the absence of basic tracking and reporting can lead to large revenue losses and decreased cash flow during a recession. This occurs because growing problems are overlooked when you only rely on month-end assessments. Continual monitoring allows you to be much more proactive.
With this handful of critical metrics, you can avoid being blindsided by cash and revenue issues that can cripple your company. A modest amount of effort can help you address growing problems before they metastasize. The reporting functions now common to most accounting software and AR automation applications can reduce the work substantially.