Manage Debtors And Creditors To Improve Liquidity
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Sales turnover and net profits may follow a rollercoaster pattern familiar to
most business but when the cash flow dries up the game is over. Urgent attention
to the management of working capital can provide every business with the cash
resources to exploit its potential
Most businesses will experience periods of lower sales and times when losses may
be incurred as expenses exceed sales income. The situation is recoverable by
producing higher sales and reducing costs and expenses. A business that runs out
of cash resources is dead in the water.
Debtors and sales income management
The objective is to obtain payment from customers as fast as possible improving
cash flow and minimising the risk of bad debts and not being paid at all.
Payment terms offered to customers should be clearly stated and fixed as
standard accounting figures according to the amount of funding the business is
prepared to offer its clients. Because that is exactly what credit terms to
customers is, free cash funding in exchange for eventual sales income.
Consideration should be given to using a cash discount system to encourage sales
invoices to be paid faster. In some businesses it would be appropriate to obtain
up front deposits and scheduled payments. Review this practise to obtain a
greater proportion of payments faster to improve liquidity.
New customers should be subjected to a strict credit check. All new customers
where credit check details are not available should be invoiced by the
accounting function on a pro forma basis. Any businesses who fail to meet the
highest credit score required should remain on a pro forma invoice basis.
The credit control function needs consideration from the first step of issuing
customers with a sales invoice, producing customer statements of the debt owed
and a set procedure of credit control letters and telephone follow ups that
actually achieve the end result of getting the cash in. An essential process in
the credit control procedure would be to ensure the accountant or bookkeeper
always issues sales invoices and customer statements promptly.
Incorporate into the terms of trade a set of rules to invoke interest payments
for late payment and late payment debt recovery costs. In the UK the Late
Payment of Commercial Debts (Interest) Act 1998 sets out the statutory rights of
business to claim interest and costs.
Consider the possibility of factoring sales invoices due from debtors either by
selling the sales invoices to a third party or raising cash on the value of
those invoices pending payment. Factoring has the disadvantage of often not
being cheap but does have the advantage of generating a regular stream of cash.
Bad debts have a double impact on any business and all possible steps should be
taken to reduce the risk. A bad debt not only uses valuable resources in chasing
the debt with the negative impact on cash flow and liquidity but also is a
straight loss to the net profit and a strong indicator that the accounting
function is failing the business.
Creditors and expenditure management
The objective is to extend the time allowed for payment of expenses the business
Consider the frequency of all payments made to suppliers. Small business have
alternative payment terms available for the payment of taxes. In the UK value
added tax can be paid quarterly or monthly, vat cash accounting can ease the tax
liability due in critical periods and paye payments can be paid quarterly rather
than monthly for smaller businesses.
Every opportunity should be considered to improve liquidity and that would
include the frequency which employee salaries and wages are paid. A sensitive
area since it involves the most important people to the business success but
adopting a payment period to coincide with the receipt of cash from customers
may in some circumstances balance liquidity.
General creditors are a major area to be addressed in terms of both the amount
of credit received from suppliers and the time required to pay those creditor
accounts. Larger orders on extended payments terms creates a risk area should
the goods not be used but can greatly assist cash flow as the business is
effectively borrowing free cash from its suppliers.
Stock levels are crucial to financial management of the creditor total. High
stock levels use valuable working capital which is offset in part by the level
of creditors. Higher levels of stock financed by free credit from creditors
lowers the cash flow requirements on the other parts of the business.
About the Author
Terry Cartwright designs UK Accounting Software at
http://www.diyaccounting.co.uk/ on excel spreadsheets providing complete
http://www.diyaccounting.co.uk/smallbusinessaccounting.htm for small to
medium sized businesses
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Article Published/Sorted/Amended on Scopulus 2008-05-09 14:21:26 in Business Articles