Up Your Cash Flow!
Becoming More Systematic in Your Collections Is a Surefire Way to Improve AR Performance
A client, who rented heavy equipment to manufacturers and construction firms across a multi-state market area, was saddled with an accounts receivable (AR) growing faster than revenue. In other words, they weren’t collecting everything being sold. Three staff members handled both customer service and collection duties, while the Controller managed credit. For the most part, the customer service team only addressed collection issues when a customer placed a new order, which was woefully inadequate.
The CEO and Controller thought the problem was their small accounts due to the excessive time customer service spent working with those customers. An analysis of their AR portfolio, however, found that the bottom 60 percent of customers accounting for only 10 percent of revenue actually paid fairly well. The top 10 percent of customers accounting for 55 percent of revenue also generally paid well. It was the middle tier, 30 percent of the customers accounting for 35 percent of revenues, that were creating the most cash flow problems.
It turned out that the company had established good relationships with their largest and most frequent customers, so there were relatively few misunderstandings affecting payments. The rental agreements with these periodic customers involved relatively straightforward transactions and therefore few problems. Likewise, small customer transactions were very basic and so raised few complications. Collection problems were occurring with the mid-tier clients because the rentals were larger and more nuanced than those with the small accounts, and these customers were less familiar with the rental terms than the top-tier of customers who rented more frequently.
To right the ship, my client outsourced collections on a first-party basis with an AR management firm to ensure adequate collection coverage, especially on the middle tier segment. Over the 6 month period needed to get caught the past due AR back within acceptable parameters, the effort contributed over $1 million in additional cash flow (the total AR balance fell by that amount) despite an incremental increase in sales.
A Flawed Collection Process
Like many other businesses, this company had grown organically, and over time expanded its geography from a single location to a multi-state, regional operation. In so doing, the immediate need was for greater customer support to keep up with the expansion of sales. Additional collection support was not seen as a priority because sales and cash flow were both rising. However, cash flow was under-performing all along, and that did not become apparent until after the AR had ballooned up. The poor cash flow was compounded by two major flaws in this firms AR management:
The volume and quality of their collection effort was far below what was required for the size of their receivables. Typically, customer service reps don’t like collecting and as a result, do not perform well in that regard. The intermittent collection effort, furthermore, did not convey to the customers an expectation of on-time payments, nor were collection activities being launched on a timely basis. Recent past due accounts were not being contacted at all unless the customer wanted to rent additional equipment. The AR balances that were over 30 days past due were not being worked systematically and were being contacted too infrequently.
There was no focus on the poorest paying customer segment, as this had not been identified by management. Being primarily a customer service as opposed to a collection function, most of the staff’s time was spent handling customer initiated issues, and the largest volume of those stemmed from the small customer segment.
Clearly, there was an absence of any sort of Systematic Collection Process.
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Implementing a Systematic Collection Process
Collections involves a process of contacting customers to secure payment for invoices that have aged past their due date. The eternal challenge for collectors is that at most firms there are always more customers to be contacted than time and resources allow.
The solution is to use a rigorous, efficient process to maximize the number of customers contacted effectively; in other words, a Systematic Collection Process we call PETE: Prioritization, Execution, Timing, and Escalation. Here are the details:
Prioritization: specifying in which order you will contact your past due customers to maximize results. Customers are typically prioritized by amount of past due AR, credit risk rating, and balances over 90 days past due. As a general rule of thumb for ongoing collection efforts, we recommend contacting customers who have broken payment promises first, then any other accounts that require a follow-up (for example you left a message two days ago and they have not responded yet) and then all remaining accounts in descending order of their past due balance. This will maximize your dollars collected. When you are starting out, or in a catch-up situation, you may want to bring risk ratings and over 90 balances into you prioritization scheme. Click here for more on prioritization.
Execution: Collection Contacts can be made via phone call, email, or even text message. Phone contacts are the most effective, but email can provide greater coverage, especially when automated for high volume contact. Phone calls should therefore be allocated towards higher dollar and older balance accounts and emails to lower dollar and more recent past due accounts. Your mix will depend on the resources you can deploy — limited resources favors more emails to cover every past due whereas more calls can be made if you have the human capital to do so. Text messaging is gaining usage as an adjunct to calls or a substitute for emails. Texts are most effective as a reminder when an invoice is coming due or just past due and in follow-up or reminder situations (e.g., did you send your payment today as promised?)
Timing: Collection efforts are typically initiated a few days past due for large and/or risky customers. You might even reach out to some of these customers before an invoice is due to make sure there are no issues that would delay payment. For smaller customers, emailing a reminder no later than when they are 7 to 10 days past due is recommended. Also, it is wise to check your customers’ payment histories. For customers who habitually pay 5 days past due, don’t bother contacting them until they are 10 or more days past due. After the initial contact, you will want to keep the pressure up with subsequent texts, emails, or calls.
Escalation: An escalation protocol defines the steps to be taken and their timing, to protect your company from bad debt losses. When past due accounts break promises or do not respond to your collection efforts, they are at risk of default. It is therefore important the urgency of your collection efforts increase along with the strength of you messaging while the intervals between collection activities become shorter, as a receivable ages. The timeline starts with routine collection follow up when amounts are a few days past due, progresses to order hold, then a formal final demand, ending in referral of the account to a collection agency or attorney.
The Need to Be Strategic
The idea is to have a strategic approach to your follow-up methods that ensures comprehensive coverage in line with the human resources available for getting the work done. Texting take less time than emailing, which take less time than making calls. Collection automation software allows you to do more of these tasks in even less time. A collection strategy ties together these four tactical components of a systematic collection process. Here’s more on strategic collections.
Your collection strategy is best implemented when you first have a thorough understanding of your receivables landscape. Performing an AR portfolio analysis is akin to mapping out your AR landscape. Once done, you can clearly see the hidden obstacles that are obstructing your cash flow. Whenever I have conducted an AR portfolio analysis for a client, there were unexpected findings, which could then be easily remedied. Because of the unknown that is likely lurking in your AR portfolio, failure to do the analysis is a clear path to under-performance.
Final Thoughts on Collection Performance
There are a variety of activities that affect AR performance. If billing and payment posting are not done in both a timely and accurate manner, performance will suffer. If credit granting is too generous the risk of slow payments and bad debt losses increases, but if too restrictive sales and profit opportunities will be missed. Likewise, a lack of collection activities will lead to slow payments and bad debt losses.
A comprehensive collection regimen, however, will increase cash flow and reduce bad debt losses. In fact, a systematic collection process can somewhat compensate for liberal credit extensions. A strong collection effort is very simply your best bet against slow payments and bad debt losses. This observation is supported by the fact that the biggest gains in AR performance are realized from automating collections in comparison to automating any other aspect of the order-to-cash process.
Collections are a critically important function for any company that extends credit. As such, it should be executed with a well-defined, formal process, adequately resourced and monitored. Moreover, collection automation can help tremendously in both effectiveness and efficiency.