Are Collections a Priority?
Prioritizing Collections is Essential to Maximizing AR Value & Performance
As businesses grow and add customers, there comes a point when collections become a burden. This will generally occur before a company reaches 100 customers on open account, but certainly before they acquire 200 customers. Once you are dealing with hundreds of customers, the time required to contact everybody who has gone past due becomes substantial, and will require a dedicated effort, rather than an ad hoc approach.
The first step toward a dedicated collection effort involves prioritization. This is a simple matter of efficiency aimed at collecting the most possible dollars with a minimum of effort. In smaller enterprises, whoever is charged with collections - customer service, the bookkeeper, or even an owner - has other primary duties, which makes collections a distraction, and as such a task likely to be given short shrift.
The benefits from prioritizing collections can be substantial, especially if your collection efforts have fallen behind. The following example involves a large company, but the principals are the same for small and mid-sized firms.
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Collection Prioritization Drives Performance Improvement:
A medical device manufacturer with $1.6 billion in annual sales was dissatisfied with the management of its Accounts Receivable (AR). Days Sales Outstanding (DSO) was at 63 days on predominantly Net 30 day terms. In response, two actions were taken:
The firm implemented and enforced a new Collection Prioritization Methodology that focused the majority of effort on the 11% of customers who controlled 71% of the past due/high risk AR
The company also improved the quality and promptness of its collection contacts
The results were impressive - over the next eight months:
DSO was reduced from 63 to 41 days
$61 million in AR was converted to CA$H
Bad debt expense was reduced by $2.2 million
These two simple, common sense changes to the Collection Process delivered huge results…the fundamentals of good AR Management never go out of style!
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Implementing Collections Prioritization Policies and Procedures
Before beginning the prioritization process, you need to understand the dimensions of your AR portfolio. The AR Ledger provides a list of every customer who owes you money and every open transaction on their account. These transactions can include whole open (not yet paid) invoices, the residual amounts of invoices not paid-in-full, payments made on account and open credit memos. All open items should be aged from the transaction date.
As you review your AR Ledger, start by asking these Key Questions:
How many accounts are past due?
How many accounts have significant balances that are over a week past due
How many accounts are seriously delinquent (over 60 days past due).
Are there one or two past due transactions per account or do some accounts have dozens or even many more open invoices?
Knowing the dimensions of your AR asset allows you to quickly determine how much time is required to contact your past due accounts. Plan on making a call and follow-up email to the customers owing larger balances along with the seriously delinquent accounts. Factor in more time for the accounts with a significant number of open transactions. You can also figure on starting with a standard collection email to the accounts with smaller balances that are less than 30 days past due, and then follow them up with a phone call after you have contacted the accounts owing larger past due balances.
This isn’t complicated - a quick back of the envelope calculation of the time required to contact all your past due accounts will suffice. If too much time is required, reduce the number of calls and increase the number of emails. In subsequent collection cycles, when hopefully there is less to collect, you can bump up the percentage of calls as time permits.
The next step involves ranking your past due customers in the order they will be contacted. Here’s how you should Prioritize Your Collection Activities:
Anybody who has promised you payment and subsequently failed to do so (failing to follow up is a waste of your initial collection efforts and sends the message that you are not serious about collections)
Largest balances owed in descending order that you will phone - this group will also include your calls to any account that is seriously delinquent (collecting the most dollars possible requires going after the largest balances first, no matter how far past due they are)
The remaining accounts (smaller balances that are not seriously delinquent)
There are automated collection tools that generate prioritized collection queues, but in the absence of such a tool you can pretty much eyeball the data and manually prepare a prioritized list. Better yet - especially if you have more than a few dozen past due accounts - run an AR aging report that lists past due accounts by descending balances for each past due aging bucket (oldest bucket balances first). Once you work through the collection cycle a few times, prioritizing your collection efforts in this way will become routine.
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Final Thoughts…
There is one other consideration: the financial strength (or credit rating) of all your customers. With the economic headwinds we are currently facing, the risk of not being paid in full by your largest volume customers along with any other accounts that owe your firm significant dollars requires extra attention.
To mitigate the risks from customers in who may be under duress, you will need to coordinate any new sales with your collection efforts in order to reduce your AR exposure from month to month and even week to week. A simple way to do this is to hold orders until an equal or greater amount of existing balances are paid. Putting old balances on a Promissory Note with the requirement that new orders be held if any Note payments are missed, along with a stricter credit limit for new sales is another tactic that will help you reduce your exposure to risky customers. Check out this article for more risk mitigation techniques.
By implementing this prioritization process, your collection efforts will improve cash flow and reduce your exposure to delinquent receivables. It’s all about making the best use of your time and being diligent.