Building efficiency in accounts receivable

Cash flow can be improved through a well-designed process that incorporates data analytics.
Building efficiency in accounts receivable

Cash is critical to running any business, and accounts receivable management is key to cash flow management.

"In our accounting services practice, business owners are always looking for ways to better manage their cash flows, and accounts receivable management always comes up," said Gabrielle Luoma, CPA, CGMA, the CEO and founder of MOD Ventures LLC, a US-based accounting firm.

Many businesses continue to use at least some manual, paper-based accounts receivable processes, where poor billing and collection processes can result in lost revenues and a lack of liquidity.

"Any business needs policies upfront, including setting expectations early on about how clients will pay and setting deadlines or milestones within the systems so that everyone is on the same page about when bills will be paid," Luoma said. "Companies that get into business without payment policies in place can find their accounts receivable are out of control one to two years later, and they do not have cash to pay their bills."

So how do businesses design and implement best practices in accounts receivable? The following areas can help.

Credit checks

Perform customer credit and background checks upfront to confirm the customer's existence and creditworthiness. In many countries, third parties can provide credit scoring and other information that should be combined with in-house business judgement and qualitative analysis.

Some businesses use preapproved credit limits, but others do not. Andrew Parris, director of Shared Services for Tarmac, a sustainable building materials and construction solutions business in the UK, said his company does not have preapproved limits. Tarmac does, however, consider performing comprehensive credit checks on all customers an essential part of its operations.

"In our industry, building materials and construction, there are many sole proprietors and frequent changes in business names, so it is critical that we continue to confirm their existence and creditworthiness," he said.

Tarmac uses customer credit scores and risk ratings from a credit bureau and reviews and maintains customer files.


Determine and document all terms of the customer agreement in writing upfront, before any goods or services are provided. The terms should include the scope of work, payment method and timing (upfront fees, retainers, percentage or progress billing, final payments), and collections (timing, penalties for late payments). The contract could also spell out the process if the customer were to be dissatisfied with the goods or services provided, to avoid this becoming a collections issue.


Bill customers timely and accurately, and make sure the invoices get to the right person.

"More of our clients are using some form of electronic invoicing, either by email or accounting software," said Nicole Eshnaur, CPA, CGMA, a manager at MarksNelson, a US-based accounting firm. "Also, more of our clients are using third-party accounts payable applications, so it is easier for them to receive invoices electronically and reduces the time it takes for them to be paid."

Electronic invoicing can give customers quicker access to bills and statements on demand, which can improve customer satisfaction and potentially result in faster payment. It also saves on postage and reduces the risks of invoices getting lost or not going to the right destination. Tarmac offers customers electronic data interchange (EDI) and batched or consolidated billing on request, which can make the customers' payment processing easier.

Integration of the invoicing and sales processes can increase timeliness and reduce errors.

"For the majority of our invoices, tickets are issued through our sales order processing system, and billing is done daily as tickets are processed," Parris said.

To ensure that bills are complete, Tarmac allows a three-day review period before the bills are issued in case any amounts need to change based on products delivered. Use of accounting software and integration can improve operational efficiency.

"It can be ERP, or QuickBooks, or other small business accounting software with a point-of-sale or invoicing application that integrates directly into the software," Eshnaur said. "For instance, a business may take orders on an iPad, update warehouse inventories, and have a purchase order generate an invoice through an application that integrates with QuickBooks, which removes some data entry and saves time and resources."

Progress billing may make sense depending on the goods or services provided.


Establish a collections policy that works for your business and customers and follow it.

"It should be a management decision on how to handle collections overall, including how lenient or harsh to be, and then have policies and procedures for who within the accounts receivable team does what," Luoma said.

The policy could include how to escalate nonpaying customers, when to send reminders, when to use collection letters, and whether to use late fees and interest penalties. The decision about whether finance charges should be assessed may require legal review because rules and requirements can differ by jurisdiction.

Reviewing ageing reports is a widely used practice for monitoring accounts receivable. The collections policy for ageing may vary by industry, but it should include how to follow up with customers based on the age category of the receivable, such as any balance over 60 days old, and whether it should be by phone or in writing.

"We utilise a monthly report of customer risk ratings from the credit bureau and correlate it to the ageing report," Parris said. "Then the credit managers do a qualitative review of the two together and apply their judgement to come up with the need for an allowance, because bad debt decisions are not just about the numbers."

Software can be used to automate the dunning process. Parameters can be defined by customer within the system for the dunning sequence and number of days at which different types of reminder or collection letters are generated and sent to customers. Different letters can be created based on customer payment history and risk profile.

Tarmac introduced robotic processing for allocating receipts from the bank statement to customer account balances. The company is working on using artificial intelligence to teach the technology to improve how it allocates future cash receipts from the same customers.

In addition to collection policies, customer communications are important.

"Our overall strategy includes "˜people first', which includes the people on the other end of the phone," Parris said. "[Collection discussions] may be confrontational by nature, but if you are respectful and form personal relationships with your customers, it makes it so much easier to talk to them about paying their bills."

Timely communications are key

"Your opportunity to collect is usually best within the first 30 days," Luoma said. "The longer an invoice is outstanding, the less likely you are to collect it."

Parris said, "We may make pre-emptive calls or send emails before month end depending on the relationship with the customer."

Luoma suggested it might be useful to identify one person within the collections group with strong communication skills to handle unusual customer situations.

Customers may be incentivised to pay sooner if companies offer discounts for timely or early payments. It is becoming more common for businesses to accept credit cards, although many still do not. Giving customers flexible ways to pay can improve customer satisfaction and payment timing.

"Fewer customers are paying by cheque, and there is free software available for electronic payment and bank transfers," Luoma said.

To accelerate collections timing, some businesses factor their accounts receivable. But Luoma warned that factoring companies may take as much as 25% of the receivable balance.

"If you have good policies and procedures, you should not need to do this, and very few businesses have enough profits to give away that percentage," she said. "Overall, cash flow is what accounts receivable management is really concerned with. There is a definite cost of bad cash flow management — interest, debt, and reduced opportunities for business development."

Fraud risks

Have a reliable, efficient system for processing customer payments. Handling cash and depositing cash receipts present opportunities for fraud. Automation helps by eliminating some of the human factor.

"Use drop boxes and electronic payment capabilities rather than manual processes for opening mail and depositing cheques," Eshnaur said.

Segregation of duties and a second reviewer are good internal controls when manual processes are necessary.

As the subsidiary of an Irish company that is listed on a US stock exchange, Tarmac complies with US regulations for maintaining internal controls over accounts receivable, Parris said.

"Because a high proportion of our customers pay by cheque, we segregate the duties of opening envelopes and recording, and scan payments in immediately," he said. "Cash may also be collected at the customers' sites, so there are daily reconciliations of cash receipts."

To reduce fraud risk, use automation in the billing process and integrate billing with other processes. At Tarmac, employees cannot modify purchase orders or create new customers, because these transactions are done through the sales system. Integration eliminates some of the human factor that might lead to fraud. Fraudulent credit memos can be another area of fraud risk that can be reduced by integrating them with the sales and return systems. 

It's important to have strong internal controls in place over accounts receivable processes and to have regular conversations with employees about accounts receivable fraud risks.

Data analytics

Use data analytics to gain insight into accounts receivable and improve credit and collections management. Accounts receivable analytics can consist of reviewing ageing reports or calculating ratios such as days sales outstanding and accounts receivable turnover.

Accounting software can provide the ratios, and dashboards can generate regular reports that support the accounting department's review of accounts receivable and management's decision-making related to expected collections. Luoma recommended having conversations with the sales team about deals in process and expected close rates, along with expected sales growth rates this year compared with last year, to help management estimate the timing and seasonality of cash flows.

Analytics in this area can also include looking at individual customer payment behaviour and invoice history and reviewing trends across the entire accounts receivable department. The information can then be used to make choices about credit policies and collection approaches going forward, with a goal of reduced risk, better accounts receivable management, and improved cash flows.

Historical data can also be used to predict future customer behaviour. For example, looking at historical data on disputed invoices and patterns of late payments could anticipate future write-offs and identify areas for future process improvements.

"The use of data analytics is still new to many of our clients, and since the software can be expensive, many small and medium-size businesses are doing what they can themselves," Eshnaur said. "They know it's coming, especially in the use of predictors for planning."

Tarmac is not currently as advanced in the use of analytics as Parris would like it to be, but the company has plans to change this.

"We would like to have one-stop, real-time information on any device. Today, we export data into Excel, pivot, reconcile, aggregate, create PowerPoint presentations, publish, and then do it again and again with updated data," he said. "At times, there is little insight — just data."

Parris also would like to see his company be part of the move that is already underway away from using predictive analytics, where data is used to anticipate future risks, to using prescriptive analytics, where data is used to cause an outcome. 

An example of prescriptive analytics is applying a statistical model to historical data and then adjusting collections procedures in response. A model can be applied to a company's historical accounts receivable data, along with current industry payment information, to predict future customer behaviour and determine the probability that each invoice will become past due in the future. A collections risk score can be assigned to each customer and used by the collections department to develop targeted activities to reduce collections risk.

Companies can get started in their use of accounts receivable data analytics by building client or customer profiles or models.

"Research what's normal or expected collection experience for your industry by using your company's experience, industry data and best practices, and peer analysis," Luoma said. "And you can ask your customers what they typically do."

Assessing the steps in the sales-to-collection cycle and introducing process changes, along with identifying potential automation opportunities, can make the accounts receivable function more efficient.

"The second part of our overall strategy is 'process next', which means making sure our people understand what the process is, follow it, and improve it — all day, every day," Parris said.

In addition, improving accounts receivable analysis and implementing new data analytics techniques can provide insights to improve receivable collections and cash flows.

"Businesses need a statement of operations on how they are going to manage their cash flows, but just because you started with certain policies and procedures doesn't mean you have to keep them," Luoma said. "That's what a lot of businesses do wrong. They don't look at their cash flows as if they have power over them, but they do."

Maria L. Murphy, CPA, is a freelance writer based in the US. To comment on this article or to suggest an idea for another article, contact Ken Tysiac, FM magazine's editorial director, at