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How Accounts Receivable Factoring is a Pay Day Loan for Business

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Posted by Matt Osborn - 28 June, 2019

7 Items You Need To Start A Net Terms Program

Offering customers credit through net terms financing can be a great way to grow a small business. But handing over products before getting paid can seem like an iffy proposition. To help ensure that your net terms program gets off to a good start, we're going to cover seven items that should be part of any credit policy.

Define The Process

Understanding how invoices and payments will flow through accounts receivable is about more than issuing invoices and collecting payments. There's a number of moving parts that must be factored in. These include:

  • How will invoices be issued - paper or digital?
  • What happens when a key employee quits or calls in sick?
  • How will creditworthiness be verified?
  • When should a customer receive better terms?
  • Should new, unknown customers receive credit? If so, how much?
  • When should reminders be sent?
  • What happens when a customer doesn't pay or goes out of business?
  • What net terms should the company start with?

Once the process is defined, it should be well documented so that employees can read through it. A document also allows new employees to learn a standard process.

Setting The Right Net Terms

In most cases, setting net terms involves more than trying to set terms that are favorable to your business. What's favorable to the customer must also be considered. A good place to start is with your industry's average net terms. Most industries will have an average days sales outstanding (DSO) that customers pay. For example, net 60 might be the average terms for an industry. Trying to use better terms such as net 45 probably won't work in that industry. Customers are expecting net 60 or something more favorable (i.e., 75 or 90).

If your industry doesn't have standard net terms, try starting with a small number since it is more favorable to cash flow. If you start at net 30 payment terms and customers complain, you can go to net 45 or 60 to see if there is higher satisfaction among customers.

Of course, any net terms need to make sense from an operational point of view. If suppliers are net 45 and customer terms are net 90, there's a 45-day window that you'll need to finance. That gap will need to be decreased as you'll eventually run out of cash. Negotiating better terms on both ends can help close the gap. Suppliers might go to net 50 while customers are ok with net 60, creating only a 10-day gap. Whether that is enough or not will depend on how well-managed the company is.

Qualified Employees

Employees who know how to run A/R are critical to good cash flow performance. Smaller companies may only need one person to run A/R. But what happens when that person calls in sick or decides to quit? It will take time to train another person.

While having more people than needed full-time on A/R isn't efficient, companies can get around this problem by rotating in people from other departments. There are a few advantages to doing this:

  • More than enough people are trained to manage A/R.
  • Rotating people in keeps their skills and knowledge of process fresh.
  • Rotation allows additional eyes into the process, which can help with spotting suspicious activity.

Verify Creditworthiness

Not all customers will be given net terms financing. Well-known customers with verified financial stability will be given the best terms. New customers who are startups and aren't known throughout the industry are high risk. These customers may start off with no net terms or some that are more restrictive. Once the customer has established a payment history with the company, their terms can be upgraded.

To verify a customer's creditworthiness, services such as Dun & Bradstreet and Experian can be used. These services are the equivalent of a personal credit score and provide a quantitative method for choosing customer net terms.

Contingencies

Along with all the machinery required to extend credit comes the potential for things to go wrong. When they do, having a plan in place will help to ensure everything continues running smoothly. This is where contingencies come in.

Going back to the operational manual mentioned previously, contingencies should be part of this same manual. For example, if a company is overdue on its payment and you find out they've gone bankrupt, this shouldn't create a panic situation. It's a rare but possible outcome. The debt should be written off, the account closed out, and any impact to cash flow taken into consideration. After a few of these, they become normal operating procedure while at the same time, the creditworthiness process is improved in an effort to avoid customers who may go bankrupt.

Contingencies can't account for everything. But the longer a company is around, the more problems it will face. All of those problems and their solutions can be folded into contingencies.

Consider Factoring

Depending on where a company is in its life, it may struggle to get net terms right. The result can be sporadic cash flow and a bank account that is barely covering its monthly maintenance fee. Startups fall into this teething group more than mature companies.

While net terms and A/R, in general, are being sorted out, factoring is an option that can improve cash flow. Factoring means handing outstanding invoices over to a company called the factor. The factor advances around 80 - 90 percent of the outstanding invoices' value. The remaining minus a fee is advanced after the invoices have been paid.

Factoring isn't free, but if the company needs some breathing room temporarily, factoring can provide it. 

Automatic Accounts Receivable

Looking to automate and streamline your A/R? Apruve's accounts receivable as a service saves 35%+ in cost over traditional B2B credit management practices. 

Automating A/R reduces a lot of the labor needed to keep things running. Customers can receive invoices digitally without human intervention. Invoicing and accepting payments online means being paid quicker because time in transit is eliminated. Digital payments are processed automatically as well.

Setting up a net terms financing program isn't something that happens in a few hours. Building a solid foundation that allows your A/R to grow will save time and money. We hope the tips provided in this article will send you down the right path to creating a successfully net term program.

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Topics: Finance, accounts Receivable, Payments