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How to improve a business's average collection period

Speeding up the time it takes to collect outstanding debts can greatly improve a business’s cashflow. Here, we look at some ways to improve it and stay on top of it.

By Stephen Leeves
How to improve a business's average collection period

Get it right from the start

Having a proper functioning credit department, even if consists of just one person, is an important element for any successful business, and the job of the credit department should start well before any sale has been made.

There are two major reasons why a business might have a poor average collection period. It could be that it’s selling to bad payers in the first place. The other question to ask is, once the sale has been made how vigorous is the business in making sure payment is made when due?

Know who you’re selling to

The first point is important, and with numerous credit reference agencies providing online information about the payment habits of most businesses, the decision of whether to sell on credit or not should made easier. As well as providing payment history data, reports from credit agencies can also include a potential customer’s financial accounts with notes on vital ratios relating to liquidity and solvency.

The credit department should take all of these things on board when an order is placed, and only when it’s confident that the transaction is a prudent one, approve the sale. Once approved, it is also important to ensure that the invoice is correct in all its detail. Any slight discrepancy can give a customer an excuse to dispute it and delay payment.

If you don’t ask, you don’t get

Any sale is only profitable when it’s been paid for, and for each week that goes by without payment, the profit margin is reduced. This should be the focus of any credit controller.

Most accounting software packages will provide a detailed aged debtor report listing all customers due invoices in terms of age. This report should be the basis of all collection activity with telephone calls made as soon as an invoice becomes overdue.

A record of all debt chasing activity should be diarised and any follow-up action rigorously adhered to. If legal action is threatened, then it must happen.

The software will also generate customer statements which are a useful reminder of impending due payments. It is important to keep a regular check on the collection period and set targets for bringing it down. By use of a simple average formula called "days sales outstanding", it is possible to spot any deterioration and target resources in that area.

Diligent credit research coupled with consistent collection activity, and following up when a customer's promise to pay doesn't materialise should ensure a lowering of the average collection period.

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