The Constant Battle of Accounts Receivable

The Constant Battle of Accounts Receivable

Distributing specialty tools and accessories can be very competitive, which causes companies to sell products to many different types of customers. Despite a customer's size companies can not discriminate against them solely on previous purchase history. Every customer has the right to purchase products, but how and when they pay is the million dollar question. Many companies are streamlining their accounts receivable departments to assure that payments are received in a reasonable time.

When a company allows its customers to purchase products they must also decide on payment arrangements. A thorough credit check is done to view previous purchase and payment patterns. The credit report shows previous as well as outstanding balances that a company is carrying and how up to date they are with making payments. The credit report also shows any accounts that a potential customer may be delinquent on as well as possibly sent to collections as a result of non-payment. This report rates a potential customer with a score of 1 to 100 based on their potential risk of non-payment. After viewing a customer's credit report a firm can determine what type of payment terms they are willing to offer.

When a potential customer's credit score comes back with an above average score, credit terms may now be given. Credit terms are a seller's policy with respect to when payment of an invoice is due and what cash discount if any is allowed. Many companies require that invoices be paid within a 30 day time period. Firms also offer some additional discounts for invoices that are paid within a stated period of the invoice date. My company was well as many others us 2% / 10 net 30 day terms. This means that customer's are given a 2% discount off of their face of invoice if payment is received within 10 days of the invoice date. This does not seem like a huge discount, but many companies take advantage of this cash discount when paying for products that they already need in the first place.

Cash discounts are discounts that the seller offers the buyer for prompt payment. This discount is solely at the cost of the seller because they are not receiving the full amount of the sale. These types of discounts for sales can be deducted from the total sales on the income statement. The reduction in selling price allows a company to come up with the net sales amount that will be reported on the balance sheet. The balance sheet is also affected because it must show the reduction in accounts receivable by the amount of the cash discount that some customers will take advantage of and pay within the specified discount period.

Despite a thorough credit check and special cash discounts, some customers still do not pay on time and even worse there are some that do not pay at all. When companies allow customers to purchase products on credit, they know that some of the customers are not going to pay. A constant scenario that I see in the construction industry is that firms would rather have accounts receivable issues than to lose business to competitors. A small percentage of bad debt losses are always expected when companies offer credit terms. This is why many companies have developed stricter policies to keep losses at a minimum.

When payment is not received after an agreed upon time companies are sometimes forced to send the customers to a collection agency. Collection agencies help to increase the chances of collecting payment because their sole focus is to collect payment from overdue accounts. Collection agencies also lower the company's overall time and money spent managing their accounts receivable. Recent economic conditions have forced many companies to become familiar with bad debts and uncollectable accounts. Bad debts expenses or uncollectable accounts expenses are an estimated expense recognized in the fiscal period of the sale, representing accounts receivable that are not expected to be collected. This is where the allowance for bad debts comes into play.

Allowance for uncollectable accounts or allowance for bad debts is the valuation allowance that results in accounts receivable being reduced by the amount not expected to be collected. This may seem like an extra step but accounts receivable can not be reduced until the exact accounts that need to be written off as uncollectable are indentified. This process takes place throughout the fiscal year as collection problem accounts are brought to the company's attention. An account is written off when accounts receivable does not expect to ever receive payment.

Companies are always going to have customers that do not pay, but as long as firm accounts receivable procedures are in place companies should stay in the black.

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