Best Practices in Accounts Receivable Management

Accounts receivable management plays a central role in sustaining an organisation’s financial health. The process involves overseeing the collection of outstanding payments from customers, ensuring that payments for products or services sold on credit are received in a timely manner.

Handled effectively, accounts receivable management ensures timely payments, better client relationships, and improved liquidity. On the other hand, ineffective AR management can lead to lost revenue, poor cash flow, and operational inefficiencies.

6 key considerations in accounts receivable management

A proactive approach to accounts receivable management is significantly more effective than a reactive one. By anticipating potential issues and implementing strategies to address them, businesses can ensure healthy cash flow and build strong client relationships.

Here are essential best practices to consider in accounts receivable management:

1. Make payment easy for the customer

Providing an easy way for customers to pay is essential for minimising late payments. Customers may have experienced issues receiving, understanding, or paying your invoices. Without a clear process and payment method with support available, customers will find it more difficult to make payments on time, impacting cash flow and relationships.

Payment portals and systems also make it easier for the customer. Automations that come with systems and portals can often ‘remember’ a user allowing for easier login whilst mandatory fields for payment information ensure that customers know exactly what information they need to enter and what they need to do, ensuring you get the right data to process the payment, eg. account and reference numbers.

These systems can also remind customers that a payment is due in advance, enabling proactive communication and extra time for customers to make a payment, whether its via BACS, cheque or direct debit, increasing their propensity to pay. Likewise, method of payment. Encouraging customers to sign up to a direct debit and pay their bills via this method ensures a very high likelihood of payment, timely receipt and with the correct information. This enables the payment to be processed and allocated to the correct account automatically, rather than payments with missing data stuck in suspense and collections effectively not completed.

Often, late payments are attributed to the customer. However, if your business is consistently receiving late payments, this indicates a potential issue with your invoicing and payment processes. Here are some ways to improve the payment experience for your customers:

• Ensure consistent communication - use automated billing systems that generate invoices and send timely payment reminders
• Invest in a user-friendly online platform - a  well-designed interface with easy navigation supports a positive customer experience and encourages timely payments.
• Offer clear payment instructions - clearly outline charges, due dates, and any relevant terms and conditions
• Optimise payment systems for mobile - ensuring mobile accessibility allows customers to make payments conveniently, irrespective of their location
• Provide feedback support - implement a feedback mechanism to gather insights on the payment experience. Understanding customer preferences and addressing pain points allows for continuous improvement in the payment process

2. Use invoicing software

Incorporating advanced invoicing software into your business operations can significantly enhance efficiency, accuracy, and overall accounts receivable management. Here are key benefits and strategies to consider when using invoicing software:

• Automated invoicing - invoicing software allows for the creation of templates, automatic recurring invoices, and scheduled deliveries, reducing manual effort and minimising the risk of errors
• Customisation and branding - invoicing software often provides customisation options, helping maintain a professional and cohesive brand image in all financial transactions
• Real-time tracking - track when invoices are viewed, paid, or overdue, enabling proactive follow-up and improving overall cash flow management
• Multiple payment options - invoicing software often supports online payment gateways, making it convenient for customers to settle payments using their preferred methods, thereby accelerating the payment process
• Integration with accounting systems - integration with your accounting system streamlines the financial workflow, reducing the risk of errors associated with manual data entry and improving overall accuracy
• Access anytime, anywhere - cloud-based invoicing solutions allow for access from anywhere with an internet connection. This flexibility is particularly valuable for businesses with remote or mobile operations, enabling timely management of financial tasks

3. Use accounts receivable KPIs

You should look to assess the level of effort and resource that your accounts receivable processes require, and whether a review to explore opportunities to streamline and automate would be of benefit to reduce inefficiencies and Opex costs.

To monitor your accounts receivable processes effectively, keep in mind the following KPIs:

• Days Sales Outstanding (DSO) - Measures the average number of days it takes to collect payments after a sale is made, whereby a lower DSO indicates faster cash conversion, effective credit management, and improved liquidity
• Average Days Delinquent (ADD) - Calculates the average number of days an account is overdue, providing insights into the timeliness of collections, and monitoring ADD helps identify trends in payment delays and allows for proactive measures to address overdue accounts
• Risk Segment - Measures the potential risk associated with extending credit to customers, often calculated through building bespoke behavioural scorecards and analysing account performance data
• Customer Payment Behaviour - Analyses the consistency and timeliness of customer payments, providing insights into customer payment patterns
• Turnover Ratio - The turnover ratio, also known as the receivables turnover, measures how many times a company collects its average accounts receivable balance during a specific period, whereby a higher turnover ratio suggests efficient management of receivables, quick conversion of sales into cash, and effective credit policies
• Collection Effectiveness Index (CEI) - CEI evaluates the effectiveness of the collections process by comparing the actual collections during a period to the total outstanding receivables, whereby a high CEI indicates a robust collections strategy and efficient utilisation of resources in recovering outstanding payments
• Revised Invoices - Revised invoices refer to modified billing documents issued to correct errors or address disputes in the original invoices. Monitoring the frequency of revised invoices helps identify billing inaccuracies, improves customer satisfaction, and reduces the risk of payment delays due to disputes

4. Assess customer creditworthiness

Understanding a customer's financial history is the centre of sound credit decisions, setting the tone for a healthy business relationship. Consider the following tips when assessing creditworthiness of a customer.

• Check scoring - utilise credit bureau data to evaluate a customer’s creditworthiness. Purchase bureau data from reputable credit reference agencies to access key insights into a customer or a client’s financials. Build tailored policy rules or bespoke application scorecards to minimise credit risk exposure in accordance to risk appetite. Track payment history and public records to gauge the customer’s propensity to pay.
• Data sharing - consider sharing data with a credit reference agency to obtain access to more advanced credit score and private bureau data.
• Evaluate debt-to-income ratio - gauge a customer's creditworthiness by analysing their debt-to-income ratio. Calculate the ratio by dividing monthly debt payments by gross monthly income. A low DTI ratio indicates a healthy balance, while a high ratio suggests potential financial strain.
• Assess financial reports - examine the financial reports of the client, including the cash flow statement, income statement, and balance sheet. Thoroughly review public financial statements to gain insights into the company's cash position and overall financial health.

Learn more about assessing the creditworthiness of a customer, or explore our credit risk solutions.

5. Set clear credit and collections policies

Well-defined credit terms not only protect the financial interests of the business but also encourage transparent and trusting relationships with customers. Here are some tips to consider when setting credit terms:

• Clearly communicate payment expectations by pecifying credit terms in writing. Include details such as the credit period, interest rates on overdue payments, and any applicable discounts for early payments. Make sure these terms are easily understandable, avoiding ambiguity that may lead to misunderstandings later.
• Tailor terms to customer relationships. Different customers may warrant different credit terms based on their creditworthiness and historical payment behaviour. For long-term, reliable clients, businesses may offer more favourable terms, while new or higher-risk customers may be subject to stricter conditions.
• Regularly review and adjust terms to align with changes in market conditions, industry standards, and the financial health of your customers. Being adaptable ensures that your credit management practices remain effective and responsive.
• Implement a credit limit to mitigate the risk of non-payment, establish credit limits for each customer based on their creditworthiness. This limit sets a cap on the amount of credit extended to the customer, reducing the potential impact of defaults.

Our tailored credit risk solutions help optimise your credit and collections policy. Learn more about how we can help you implement proactive accounts receivable processes.

6. Use risk based segmentation

Segmentation of customers should be based on their payment history, creditworthiness, and relationship with the company. This is important so that you know your customer, understand their needs, and know how best to treat them. Understanding these characteristics allows you to segment your customers and tailor your approach to credit terms, communication and treatment.

When implemented effectively, risk based segmentation enables businesses to optimise credit management practices, mitigate risks, and nurture mutually beneficial relationships with customers across various risk profiles. It provides a nuanced and strategic approach that acknowledges the diversity in customer behaviours and financial situations. It also allows you to stay up to date and to adjust your in-life strategies as your customers’ circumstances change over time.

Explore our risk based segmentation solutions better understand risk and manage bad debt.

Conclusion

In conclusion, effective AR management is an intricate tapestry of financial acumen, client relations, and strategic foresight. By immersing ourselves in the nuanced details of each component, businesses can not only navigate the common challenges but also transform AR from a ledger entry into a proactive tool for sustained financial success.