How to Identify and Reduce Accounts Receivable Risks

Introduction

Accounts receivable is a vital part of any business—most notably, it is through accounts receivable that businesses receive payments from buyers, and then use this income to cover operating expenses. However, accounts receivable also carries a certain risk for businesses as well. Accounts receivable risk is defined as any potential or actual setback that a company may face when it comes to collecting payments. It is important to identify and reduce accounts receivable risks, in order to maximize profits and ensure the smooth running of a business.

There are a number of factors to consider when looking at accounts receivable risk, including customer creditworthiness and payment deadlines. Identifying and proactively addressing accounts receivable risks can help businesses minimize losses and more accurately forecast income.

What are accounts receivable risks?

Accounts receivable risks can come in a variety of forms, but can generally be categorized as financial, operational, and legal risks. Financial risks are ones that are associated with a customer’s ability to pay; this includes risks such as fluctuations in customer creditworthiness or customer insolvency. Operational risks cover any potential disruptions in the accounts receivable process, including payment delivery delays or incorrect payments. Finally, legal risks are those risks that may arise from any change in laws and regulations, such as changes in tax rules or data protection regulations.

Why is it important to reduce accounts receivable risks?

Reducing accounts receivable risks is important for any business as it can help to minimize the potential losses associated with outstanding payments. Proactively addressing accounts receivable risks can help businesses to identify problem customers and predict how their customers may act in the future. It can also help businesses plan for financial surprises and better manage cash flow. All of this can ultimately lead to higher profits and a smoother business operations.

Identifying Accounts Receivable Risks

Identifying accounts receivable (AR) risks is the first step to effective risk management. Managing accounts receivable risks protects the potential losses linked to extending credit and collection of debt. Here are the four significant methods of identifying accounts receivable risks.

Analyzing customer purchase history

Analyzing customer purchase history will help you identify any customer who is likely to default on payments. This type of analysis should be done before you approve any customer orders.

Keeping an eye on industry trends

Keeping an eye on the industry trends will help you identify any changes in the AR risk landscape. This helps you identify any external factors that could lead to increased customer payment defaults.

Monitoring existing customer credit limits

Monitoring existing customer credit limits can help you identify any customer whose risk of default has increased over time. You should keep an eye on any changes in customer credit limits and update them as a risk management strategy.

Analyzing customer credit payment terms

Analyzing customer credit payment terms is another effective way of identifying AR risks. This helps you identify any customers who are likely to default on payments due to their payment terms. You should review customer payment terms regularly and update them accordingly.

Reducing Accounts Receivable Risks

Reducing accounts receivable risks requires a comprehensive approach that includes both preventive and proactive measures. Following are a few of the key steps businesses should take to limit their AR risks and protect their bottom line.

Establish and Enforce Credit Limits

Establishing an appropriate credit limit is one of the most effective ways of limiting accounts receivable risks. Making sure that every customer's credit is checked and that the credit limit is set accordingly is essential. In addition, any changes made to a customer's credit limit should be documented, understood, and approved. This helps ensure that each customer's credit risk is monitored and managed.

Establish and Enforce Payment Terms

Payment terms should be established and enforced. It is important to be clear and consistent with customers about when payments are due, and to not make exceptions. This helps ensure that customers are held accountable for timely payments and that the risk associated with any late or delinquent payments is minimized.

Offer Incentives for Early Payment

In addition to enforcing payment terms, it is important to also offer incentives for early payment. These could include discounts for customers who pay their invoices early. This helps to ensure that customers are incentivized to pay their invoices in a timely manner and that accounts receivable risks are reduced.

Require Deposits on Orders

It is also important to require deposits on orders. Deposits help to ensure that the customer is serious about their purchase and that they are committed to delivering payment in a timely manner. Requiring deposits can help to reduce the risk of AR discrepancies and protects businesses from any unexpected losses.

Other Strategies for Accounts Receivable Management

Automated Accounts Receivable Management

Automating accounts receivable management is key to obtaining visibility and compliance. Automation helps to keep data centralized, up to date, and organized, so that any changes or errors can be identified and corrected quickly. Automation tools can range from using simple spreadsheet templates to larger software implementations that integrate with the company's broader accounting system. Utilizing automation removes the manual effort of managing account receivables, allowing accounts receivable staff to focus on other areas of their role.

Integrate Accounts Receivable and Order Management

Integrating accounts receivable and order management processes allow businesses to combine those workflows that have any degree of overlap. This allows for a more unified and streamlined approach to the AR process, helping to reduce time and costs associated with managing accounts receivables. Additionally, integrating order and AR management help to provide visibility into the entire AR process—from order to invoice—allowing for more efficient decision making and improved customer service.

Establish a Collections Process

Finally, it is important to establish a collections process to ensure that past due accounts are addressed in a timely manner. This process should include an organized system of follow up, contacting customers at predetermined intervals, and a well-defined set of collection guidelines that document the procedures that should be followed in cases of late payment. By having a collections process in place, businesses are able to reduce their accounts receivable risks while providing better service to their customers.

• Set up automatic reminders and notifications
• Establish and track payment terms
• Utilize collections software to assist the collections process

Uncollectible Receivables

There are several risk factors associated with accounts receivable, with uncollectible receivables being one of the most significant ones. Knowing how to identify and reduce the risks related to uncollectible receivables can be invaluable for businesses and can help prevent significant financial losses. This article discusses the following measures that can be taken to reduce the risk of uncollectible receivables:

Establish a Reserve Fund

One of the easiest ways to reduce the risk of uncollectible receivables is to create a reserve fund. This fund should contain an amount of money that can be used to offset any losses or bad debt that may result from customers that fail to pay. The reserve fund should be replenished regularly and adjusted for any expected changes in bad debt, such as inflation or changes in customer demographics.

Power of Having an Attorney Write

It can be beneficial to have an attorney write letters to customers that are late on their payments. This can be a powerful way to remind them of their obligations and the consequences of failing to pay. An attorney will also be able to provide more detailed information about the legal options that may be available if customer payments are not received.

Writing off Uncollectible Accounts

When a customer is determined to be uncollectible, it is important to write off the outstanding invoice as soon as possible. This can help to minimize the financial impact by reducing the amount of money that is record as receivable and allowing an appropriate amount to be charged to bad debt expense. It can also prompt customers to pay sooner, as they may be more motivated to pay when the debt is still showing on their balance sheet.

Analyzing Receivables

Receivables analysis is an important part of tracking and reducing any account risk. It involves closely examining accounts receivable data, such as aging and write-off amounts, to determine specific areas that need more attention or a change of practice. Through receivables analysis, you can identify and determine the risks associated with your accounts receivable.

Using Metrics

The first step to successful receivables analysis is using metrics. Depending on your business, you may need to use different metrics, such as aging, write-off amounts and delinquent payments. Aging is a measure of how long it takes customers to pay their invoices after they're issued, and can be used to identify customers that are consistently late on payments or have large outstanding balances. Write-off amounts measure the total amount written off on accounts receivable due to nonpayment or bad debt. This can be an indication of whether your credit policies are too lenient or are being followed appropriately. Delinquent payments are those that are late, and need to be monitored closely to ensure that timely payments are being made. By closely monitoring all of these metrics, you can quickly identify any areas of risk.

Measuring Cash Flow

Another key part of receivables analysis is measuring cash flow. Cash flow is the lifeblood of any business and receivables analysis is the perfect way to monitor cash flow. By tracking cash flow, you can identify any areas where payments are late or where there may be large outstanding balances. This can help you take proactive action to ensure timely payments and reduce any negative impacts to your cash flow. Additionally, regular cash flow tracking can help you identify any areas where you may need to make changes to your business practices, such as improving customer payment terms or implementing a better credit control process, in order to improve cash flow.

Conclusion

Accounts receivable risks can have a serious impact on a business’s bottom line and reputation. To reduce the risks associated with accounts receivable, businesses must be sure to understand how to properly identify and manage these risks. This includes having strong internal processes and policies in place, such as setting up credit limits and monitoring customer payment behavior. Companies should also strive to develop and maintain a good relationship with their customers. Utilizing the right technology and employing debt collection services can also help to reduce the risks associated with accounts receivable.

Ultimately, businesses need to be aware of the potential risks associated with accounts receivable, be proactive in managing them, and utilize the proper tools and strategies to help reduce those risks.

Call to Action

If your business is currently dealing with accounts receivable risk, now is the time to act. Developing internal policies and processes can help to protect against these risks, as well as utilizing the right tools and technologies. Investing in debt collection services can also help to reduce the risks associated with accounts receivable. Don’t wait – start reducing your accounts receivable risks today.