Welcome back to our series – The Tao of Cash Flow: How to Master Your Business Finances. Over the past two weeks we have looked at what cash flow is, why it is important, and the first in a series of techniques for managing cash flow – a CashFlow Forecast.
This week we will be looking at another important technique – keeping track of who owes you money.
In this blog, we will first look at why it is important to keep track of who owes you money. Next, we will look at an important piece of terminology. Then we will learn how to use something called an “Aged Receivables” report and a few key issues related to it. Finally, we will look at a very useful formula for helping you evaluate how well you are doing. It may sound complicated, but we will explain things as simply as possible so that it is easy to understand.
So why is it important to keep track of who owes you money? Consider this situation. Maybe you run a private tutoring class. Let’s assume you have 100 customers that you tutor on a weekly or fortnightly basis. Some may pay on the day, but many prefer to pay you directly into the bank within a certain period. You offer them 30 days to pay. If you’re not keeping track, how will you know who has and hasn’t paid you in the right time frame? Is there a chance some will forget or fall through the net and not pay (especially new customers)? Do you really want to find out someone hasn’t paid for six months and have to chase them for a huge bill?
As we’ve already pointed out – lack of cash is one of the biggest causes of business failure. If you want to manage cash flow well, you need to make sure you’re getting paid, and on time.
One of the best ways to avoid cash flow problems is to have a system in place to keep track of the people who owe you money, especially as your business grows beyond the first few customers.
So let’s look at one important little piece of terminology. The key term to remember this week is “aged receivables”. Receivables is an accounting term meaning “money owed to a business”. In this context, “aged” means that it is something outstanding beyond the date it should have been paid. So “aged receivables” (sometimes referred to as A/R) is all the money that is owed to your business, but that hasn’t been paid within the correct time frame you specified.
Let’s explain this with an example. Let’s say you are a children’s activity franchise. You send your customer an invoice for £10 for a session you are running. The invoice says they have 30 days to pay. If, after 30 days they haven’t paid, then the debt becomes an “aged receivable” (prior to the 30-day deadline it’s just a “receivable”).
Now that you know what Aged Receivables are, can you guess what an Aged Receivables (A/R) report is? Exactly! It’s the report that tells you about the outstanding money owed to you by customers. In particular, it will show you what hasn’t been paid within the due date and how far out of date the debt is.
It is important to know just how far out of date the payment is. This can help you see whether it may just be a case of a customer forgetting, or whether there is a bigger problem such as they haven’t received the invoice, they are struggling to find the money to pay, or their direct debit isn’t set up correctly.
So how does it work? Well, let’s look at an example –
Looking at the image above, you can see certain things. First, along the left-hand side, you can see a list of customers with outstanding debts. Then there are several columns – Current, 1 to 30, 31 to 60, 61-90, 91 and over, and Total.
Each column shows how far out of date a certain debt is, and how much that is for.
The first column is Current. This column shows any invoices that are not out of date yet. In other words – they are within the payment period specified on the invoice and therefore the customer still has time to pay before it becomes a debt. In the example above we can see that Benjamin Yeung has been sent an invoice for £2,400 but he hasn’t paid it yet. It is fine though as he is within the period of payment specified on the invoice.
Next is “1 – 30.” This column shows the invoices that are overdue by between 1 and 30 days. It is important to note that this does not mean it is within 30 days since you sent the invoice, rather it means it is 30 days overdue/ after the date of payment. For example, you may send a customer an invoice on 1st January and specify that they must pay within 14 days. If they haven’t paid by January 15th, this debt will show in the 1 to 30 column as it’s 1 day overdue. If they haven’t paid by 7th February, they will still be within this 1 to 30 column, as it’s less than 30 days overdue. In the example above, Benjamin Yeung has not paid an invoice of £1680 on time and is not overdue.
Then there are columns for 30 – 60 days and 60 – 90 days. These show the debts that are 30 to 90 days overdue i.e. after the expected payment date. At this point, you need to make chasing them a priority.
Finally, we have the column for 91+ days. This shows the amounts owed to you by customers who are over 3 months late in payment. If you have people in this column (especially large numbers), it’s a sure sign that you are not keeping on top of your customers’ payments and are probably having or soon going to have cash flow issues. You need to urgently put a plan in place to resolve this.
There is also a “total” column which shows just how much money is owed to you. You want this to be as low as possible.
Now you know what the Aged Receivables report is, what it looks like and how to read it, let’s consider a few other issues.
First, how do you get an Aged Receivables Report? While it can be created in Excel if you really need to, the best method is to use a cloud accountancy software. Accounting software packages will have a section for reports, which will include an Aged Receivables report. If you use Quickbooks, this can be done easily by logging in, going to “reports” in the left-hand column and choosing “recommended.” Then, look for “A/R Ageing Summary” and click “run.”
The other very important advantage of cloud accountancy software here is that it will allow you or your accountant to do “bank reconciliations”, which involves checking your bank statement against outstanding invoices and marking them off when they are paid. By carrying out these weekly bank reconciliations it becomes a system by which you can easily mark off invoices that have been paid and therefore allow you to use the Aged Receivables report to track who still owes you money.
Second, how often should you be looking at the report? Managing your finances well requires developing good habits. One of the most important of these is setting aside a time each week to focus on your finances – whether that is creating invoices and expenses, uploading receipts, looking over your budgets and cash flow reports, or chasing debts. We recommend you run the Aged Receivables report on your accountancy software weekly, and then chase those who are late with their payments.
Third, how should you chase people who owe you money? Once payment becomes overdue, it is best to start with a polite email reminding them that payment is due. In most cases, this will solve the issue and the customer will pay. However, if this doesn’t happen within a week or two, it is best to follow up with a phone call, weekly if necessary, to chase the debt. Sometimes there can be a problem such as a customer is struggling with their finances but too embarrassed to mention that, so giving them a call can help you to find a solution for them. Be polite and understanding, but remember that you have the right to be paid, and you need to make sure your cash flow doesn’t suffer, so be firm in asking for the money.
Next time, we are going to be delving deeper into the issue of how to get customers to pay on time, and the processes you can put in place to help ensure this. But before we finish, let’s look at one more piece of the puzzle to help you understand how you are doing in keeping track of who owes you money – the Receivables Days ratio.
The Receivables Days ratio (also known as Days Sales Outstanding) shows you the average number of days it takes to collect money from customers after a sale is made. You want this number to be as low as possible.
To work it out, you use the following formula:
To break that down – Receivables is the value of all the money you haven’t yet been paid (whether it’s within the invoice dates or overdue). The sales on credit is the value of all the sales you’ve made for which you were not paid immediately. You divide the receivables value by the sales on credit value and then multiply it all by 365.
The figure you get is the number of days it takes, on average, to collect money from your customers. It is useful to calculate this on a monthly basis so you can compare it with previous months and see if you are getting better (or worse) at collecting debts. If this figure is going above 60 days, then you really need to focus on reducing it.
To finish this week, you have three tasks: –
1) Log into your accounting software, locate the Aged Receivables Report and run it. If it is showing any outstanding debts, it’s time to chase them with an email or phone call.
2) Find the figures for your receivables and sales on credit within your accounting software. Then use the formula to work out the average number of days it is currently taking you to collect payments from your customers. Do this again each month.
3) Think about the following questions:
And that’s it for this week. We hope you are enjoying this series and applying the practical techniques we are recommending to help you become a master at managing your business finances. Next week we are going to look at ways to get your customers to pay on time.
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