Understand the Hidden Costs of Unpaid Sales Invoices
You know that carrying accounts receivable (AR) costs you money. After all, every one of the outstanding sales invoices on your aged AR report represents your money sitting in someone else’s bank account. But the cost of financing your accounts receivable is only one part of the total cost you are bearing. There are other hidden costs that you may not have considered.
In many types of businesses, offering credit is a natural part of operations. Still, if you know the true cost of carrying customer debt, you can manage it through credit control policies. Or, you could take steps to reduce your days sales outstanding instead.
The actual cost of carrying accounts receivable will vary by company. But there are some elements of that cost that will apply to most businesses. If you want to know how much your accounts receivable are costing you, here are some areas you will need to factor into your calculation.
The first cost of carrying accounts receivable to consider is the financing costs. If customers owe you money, you will be paying interest on bank or lending fees to finance the outstanding balances of unpaid invoices, or you will be forgoing accruing interest on an interest-bearing account. Consequently, you are paying or losing interest on the balance of AR accounts.
The total cost of administering accounts receivable can be significant, especially if you have any slow-payers or delinquent accounts. It takes time to chase slow payers, and there is a cost to sending customer statements and account reminders. Even reliable customer accounts will be costing you money when they have account queries. Processing invoices and payments and reconciling accounts further add to the total AR administrative costs.
Related Article: How to Collect Overdue Sales Invoices Without Losing Your Customer
When your accounts receivable team has exhausted all its options for collecting an overdue account, you may have to resort to passing the debt to a collection agency, and that may cost as much as 25 -50 percent of the value of the invoice. Hopefully, you won’t have too many debts that get to this stage. Even so, collection costs still need to be taken into consideration in the total cost of extending credit to customers.
The possibility of bad debts should also be accounted for in your calculation. Your accountant will probably insist that you make a bad debt provision every year. However, a bad debt provision is not merely an accounting entry needed to satisfy your accountant’s need for prudence. The provision is there because the possibility of customers not paying their invoices is valid, and the longer a customer account is outstanding, the greater the risk of you suffering a bad debt. For that reason, it would help if you considered your accounts receivable turnover ratio when calculating the potential cost of bad debts.
Cash Flow Unpredictability
There is also a cost in the lack of cash flow predictability carrying accounts receivable causes. The uncertainty over when sales invoices will become cash in the bank makes forecasting challenging. And, it can be harder to make decisions when you cannot be sure what the cash position will be. Ultimately, uncertainty can lead to a slower decision-making process, which may cost your business money in the long run.
Related Article: How to Manage and Control Your Cash Flow
The following cost to consider is a little more challenging to quantify. This is the cost to your business of not having accounts receivable cash in your bank. The money that is tied up in sales invoices could be used for a marketing campaign that generates new business, for example, or you could have invested the cash in product development. Consequently, if you lower your average days sales, you will have more money to reinvest in income-generating projects. Although, if you are carrying a significant accounts receivable balance, it will cost you in terms of lost opportunities.
The time cost of managing accounts receivable extends beyond that of the AR team. Things like approving credit accounts, managing customer accounts placed on hold, and senior team members’ involvement in collections must also be factored into the AR cost. Certainly, it might also be the business owner’s responsibility to chase overdue customer accounts in a small business. And, the time spent by senior management on AR management is not only costly; that time would be better spent on revenue-earning activities.
The Bottom Line
It’s likely your accounts receivable are costing you more than you realize. Indeed, when you factor in time, financing, and opportunity costs, carrying a significant AR balance can be highly costly to a business. However, the accounts receivable cost can be reduced significantly by adopting robust credit control procedures. Every day you knock off your average days sales lowers the cost of managing AR and reduces the risk of bad debts.
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