Reducing collection risk is an excellent way to boost cash flow at your business. Most business owners treat this as something the accounts receivable team should control completely. However, improving the likelihood of collecting money owed to the company requires all hands on deck.
What Is Collection Risk?
This term refers to the possibility that you will not receive payment for goods or services you already provided or delivered. There are two types of collection-related risk:
- Internal risks are the ones your team can control, such as having an efficient invoicing system.
- External risks are beyond your control, such as a customer going bankrupt.
How Do You Measure Your Collection Period?
This period refers to the number of days it takes you to receive payment after billing a customer. This metric is important because it can give you a good indication of your company’s financial health. It can also indicate high or low levels of risk.
A high number of days means you’re not getting paid promptly, which can strain your business. This also indicates a higher level of risk. There are several more specific metrics you can use to track collection efficiency and how long it takes you to get paid:
- Days sales outstanding: DSO measures the number of days it takes you to receive payment after billing a customer.
- Average collection period: ACP measures the number of days it takes you to get paid after shipping a product or providing a service.
- Average days delinquent: ADD measures the number of days past the due date that you still have not received payment.
- Accounts receivable turnover: A/R turnover measures how often you have collected your receivables during a specific period.
- Collective Effectiveness Index: The CEI measures how effective you are at collecting payments from customers during a specific period.
What Are Some Tips for Accounts Receivable Risk Management?
Most business owners believe they can only transform their internal collection risk process. However, managing this process efficiently can significantly reduce external risks. Below are some of the many ways business owners can improve collection efficiency:
- Check creditworthiness. Before extending credit, take the time to determine whether a customer is worthy of credit and how much they should receive. Creditworthiness could even affect order sizes and payment terms. Investing in this part of the process can significantly reduce external collection risks.
- Standardize your A/R invoicing system. Have you established a process for managing your invoices? If not, you should consider implementing one. Work closely with the A/R team to create an efficient and documented process.
- Consider offering discounts for early payment. This is a great way to incentivize customers to pay their invoices, but it does cost you money. Accountants generally recommend this approach only when you have a severe cash-flow problem or have a high enough markup that provides some wiggle room.
- Communicate with customers frequently. Maintaining an open line of communication with customers makes it easier to head off potential problems before they arise. Some things to communicate include changes in your payment terms and upcoming deadlines.
How A/R Automation Reduces the Risk of Late or No Payment
One of the best ways to reduce risk related to collection is to automate your accounts receivable process. These are some of the many benefits it brings to the table:
- Reduced human error
- Improved efficiency
- Faster payments
- Increased visibility into the A/R process
- Reduced costs
With A/R automation, you can create the best possible system for effectively managing your invoices and reducing risk. Book a Gaviti demo to see what our A/R automation can help your business achieve.