What is a customer receivable? How to calculate and count them? What impact do trade receivables have on my cash flow?

What is a customer receivable? How to calculate and count them? What impact do trade receivables have on my cash flow?

Definition of a trade receivable

First of all, let’s start by defining what a trade receivable is, also called an operating receivable.

It is the right of a company to collect a certain amount of money following the issuance of an invoice to one of its customers.

Receivables arise from the fact that a company can sell a product or service to a customer and grant him a term of payment. In this case, the invoice is issued but not paid directly so it is recorded as a receivable.

On the other hand, in the situation where the payment deadline is exceeded and your customer has not paid his claim, then the claim becomes a late payment. See even unpaid if the delay is too long and the customer does not wish or cannot pay.

What is the difference between debit and credit?

It is important to differentiate between a claim and a debt.

Definition debt: it is a sum of money that is owed to another person. So it’s money you have to repay.

The difference is related to the point of view.

Debt is an obligation for the company to pay a certain sum. While the claim is a right to demand reimbursement.

How to calculate and post a trade receivable?

Calculation of customer debt and customer delay

First of all, it should be noted that trade receivables are invoices that have not been collected by the company.

However, a distinction must be made between invoices that are in the process of being paid, whose payment deadline has not been exceeded, and invoices for which the due date has passed.

For the calculation of the customer receivable, you only post invoices whose payment deadline has been exceeded.

So to calculate customer receivables you will, at a given time, add up all the receivables that you have on the asset side of the balance sheet and whose payment deadline has not been respected.

What is called the customer time corresponds to the average time for collection of receivables. It is directly linked to the payment terms that you agree to your customers.

You should know that the longer you give time to satisfy your customers, the more your cash flow will suffer.

The calculation of the customer delay is done as follows:

Customer lead time = (trade receivables / turnover) x 360

Customer receivable accounting

To understand how to post a trade receivable, let’s start by defining a related term. 

The working capital requirement (WCR) is the amount of liquidity needed by the company to operate its business and be able to continue selling its goods or services.

However, trade receivables have an impact on this WCR since they lead to a drop in available cash. The problem is that without cash your business cannot produce. She cannot sell.

For lack of cash, you risk being caught in a vicious circle that can cost you dearly.

It should be noted that the collection of operating receivables will create a difference between the recorded turnover and the equivalent collection.

This discrepancy arises from the fact that the receivables will be recorded when the invoice is issued or when the goods or services are delivered. While the payment thereof and the related cash flow will be accounted for later.

In terms of accounting, trade receivables are written to the assets of the balance sheet as financial fixed assets.

Your accountant will first register them in account 411 (customers).

Then in a second step, when the good is delivered or the service is rendered, this account will be debited to credit account 70.

When the payment deadline is exceeded, the 411 accounts are credited. And account 416 which corresponds to doubtful customers is debited.

Finally, when your customer pays his invoice, account 416 is debited. Then your cash balance will be credited with the amount.

How to manage customer receivables?

The subject of receivables management is essential to companies. Indeed, in France, trade receivables represent on average 30% of balance sheet assets. This customer item represents tied-up cash.

In addition, 25% of companies suffer from late payments from their customers, which puts them in complicated situations.

The longer your payment terms, the more it will lead to overheating of your BFR.

As a reminder, the BFR is calculated as follows:

WCR = (inventory + trade receivables) – (supplier debts + tax and social security debts)

The longer payment times increase, the greater the risk of customer solvency.

This is all the more true in the current economic context because many companies are facing a decline in their economic activity and are experiencing cash flow problems.

Thus, they voluntarily delay the payment of their suppliers, and the risk of unpaid customers increases.

VSEs/SMEs so as not to be surprised by unpaid customers, you can put in place actions to better manage your accounts receivable to reduce the risk of non-payment.

Your goal is to minimize the impact that trade receivables will have on your cash flow. To do this, you need to reduce the time between the moment your customer places an order and the moment he pays you.

To reduce this payment period, several actions must be implemented.

Set up a follow-up of customer receivables

You must set up a very regular follow-up of trade receivables. This follow-up is done from the beginning of the relationship until the payment of invoices.

To set up this follow-up, we advise you to start by breaking down the collection time of your customers. This will allow you to quickly view customers who exceed their payment terms.

For this, you have two options.

Or, you create a table for monitoring your customer payments with the Excel tool.

You will note in your Excel table:

  • The names of your customers and their companies
  • The sums that correspond to their invoices
  • The dates of payment of the invoices listed in the contract
  • The dates where the customers pay you
  • The time between the scheduled date and the actual settlement date

To save time, you can also use cash management software that monitors customer accounts for you, notifies you as soon as a customer is late in payment so that you can follow up with them.

This allows you not to take care of the administrative part related to customer reminders and to do what is necessary to notify your customers in time and avoid delays. You will be immediately alerted in the event of an unusual situation.

Analyze the causes of customer payment deadline overruns

The second step in moving towards better management of your customer receivables is to understand what causes your customers not to meet their payment deadlines. If you determine the causes, you can then act on these delays and reduce them.

Here is a non-exhaustive list of several explanatory causes:

  • A bad economic situation means that all companies are experiencing a drop in activity and are trying to postpone the payment of their invoices;
  • A distracted or careless client who has not paid attention to deadlines.

Our advice: to avoid “distracted” customers, you must set up a preventive reminder system even before having exceeded the payment deadline:

  • An invoice that one of your customers would not like to pay because he believes that the good or service provided did not meet his expectations;
  • Default of payment by the company.

Our advice: try to measure the company’s financial problems to know the customer risk.

How to recognize if a customer is suspicious?

It is very difficult to know in advance the potential risk of default by a customer.

However, here are some tips that will allow you to recognize questionable customers and minimize the risk of insolvency:

  • First of all, before signing a contract with a client, always check the financial situation of the company. Indeed, if you have the slightest doubt about this potential client’s ability to pay you or if you are about to sign a contract for a substantial amount, you absolutely must analyze the client’s solvency. For this, you can for example inquire online. Either on the Trade Register or the infogreffe website which provides information that will allow you to determine the financial equilibrium of your future clients. This site allows you, in particular, to know if your future client has properly settled his debts to URSAFF and the Public Treasury, which is important initial information. If, for example, the prospect already has debts. Be aware that debts such as taxes, rent, electricity will always be reimbursed before the debts that the customer owes you.
  •  The second step is necessary only if you are still hesitant and unsure of your client’s financial situation. You can use financial ratios to further examine the solvency of the future debtor. The use of these ratios requires a study of the balance sheet of these companies. There are many ratios you can use. In particular, there is the net debt ratio and the general solvency ratio.
  • Finally, you can notify your company’s sales representatives of this problem. They are the ones who are on the front line and who have direct relationships with future customers. They are used to it and will be better able to discern an omen from a bad paying customer. To motivate them, you can also consider commissioning them on the invoices paid and not on the contracts signed.

Whatever the situation you are facing, we advise you to find an amicable agreement. Do not forget that your customers can always choose to turn to the competition so it is often better to negotiate. This will also allow you not to embark on a recovery procedure. This type of procedure usually takes a long time and will cost you dearly.

What is the effect of customer outstandings on cash?

Trade receivables represent a very important commercial element for a company. Indeed your customers will tend to choose you rather than a competitor if you grant them longer payment terms.

However, the fact of granting deadlines to your customers can be detrimental to your cash flow.

Why? The principle is simple.

You produce a good or a service that costs you money since you have to pay your suppliers and employees and in exchange, you are not remunerated.

A gap settles between the inflows and outflows of money. The problem is that if the lag is too significant, you may run into cash flow difficulties. You will then no longer be able to fulfill your orders.

It should be noted that trade receivables have two major characteristics:

  • They are by definition risky. With a trade receivable you always bear a risk of loss of profitability if you are faced with an unpaid bill. 
  • They cost you dearly. The costs of managing trade receivables are found throughout the life of the invoice:
    • Ongoing management fees
    • Funding costs
    • Dunning costs
    • Margin erosion (any delay in meeting the deadline decreases the trade’s margin)
    • Loss on bad debts

This is why it is essential to carry out simulations via hypotheses in your future cash budget taking into account the payment period of your customers.

With reliable forecasts, you will be able to anticipate cash shifts and think about different types of financing upstream.

How can you better manage your trade receivables to avoid cash flow difficulties?

Consolidate the formal framework

Specify the terms of invoicing and the deadlines for payment of invoices. For example: “Our invoices are payable 30 days upon receipt, by direct debit”.

You can work on your terms and conditions for this. These conditions define all your contracts with your various customers, so they must be well written. For example, you can include in your terms and conditions the time you allow for the payment of an invoice and the compensation that will have to be paid by your customers if they pay late.

In the case where you sell products, you can also include a property clause in your general conditions. This clause means that you own the goods until your customers pay for them in full. So you are not obliged to send the products if they have not been fully paid for.

Finally, our last advice is to include in the general conditions that in the event of a dispute, the customer must bear the costs of debt collection. Given the cost of recovery procedures, such a clause can be beneficial to your business.

Choose appropriate payment methods and deadlines

Transform traditional means of payment into automatic means of payment. The customer should not be left in control of the payment initiative. It is therefore necessary to “impose” the mode of payment when possible. For example, immediately request bank details and have the direct debit authorization signed. Indeed, bank transfers or online payments eliminate the delays relating to the deposit of a check and then its collection. For example, you can offer your customers to use integrations such as Gocardless or Paypal that automate the collection of recurring payments. 

The contractual deadlines must be as short as possible. As we have said throughout the article: any discrepancy in the regulations penalizes the BFR of your company.

Ask for a deposit

Many companies ask for payment of a share of the good or service even before it has been delivered (from 20 to 50%). Indeed, this allows you to hedge against the risk of non-payment. Admittedly, this requires an effort from the customer. However, you can explain to him that this represents a guarantee of confidence in both directions. He is sure that you will take charge of his file as soon as possible. And on your side, this allows you to receive part of the settlement immediately and to pay your suppliers so as not to suffer from excessive cash flow gaps.

Send a very simple invoice, with all the necessary elements and as soon as possible

Do you find this advice obvious? Imagine that many companies, especially small companies that often work with reduced staff, find themselves caught up in their daily lives. They, therefore, do not have the time or the resources to send their invoices to their customers as soon as possible.

This is linked to two reasons. First of all, the lack of precision is your enemy and will allow your customers to renegotiate the terms of the contract. Then, put yourself in the shoes of your client who is also potentially overwhelmed and has little time to devote to administrative tasks. The sooner you send him the bill, the more time it gives him to settle the bill, and the sooner you will be paid.

Learn about your customers

You must facilitate any follow-up work by knowing your customers well.

Get organized and put procedures in place

The organization is essential to the proper management of your accounts receivable.

To organize yourself well, we advise you to:

  • Dedicate a person (or a team) to this function
  • Clarify roles and responsibilities
  • Reflect on procedures

Accelerate cash inflows 

Your first objective should be to accelerate cash inflows.

This will first go through an acceleration of invoicing and collections.

We advise you first of all to stagger the payments. After requesting a deposit, you can ask your client to pay you gradually until the deadline when he is supposed to have paid you the invoice in full. It’s a great way to judge whether your client is a good or bad payer. And this allows you to keep a means of pressure on your client.

For this you can for example use a method such as the discount. The discount is a solution allowing you to offer your customers a reduction if they pay cash or if they pay earlier than the date fixed by the contract. It is a solution that has a cost but many advantages since in addition to touching your cash directly, it is a way of maintaining good relations with your customers.

Then to accelerate cash inflows, you can also use a solution such as factoring. In this case, an external company will buy your debt and take care of its recovery for you for a commission. This method is certainly expensive, but it allows you to receive your payments directly and avoids the administrative tasks related to customer reminders. The “factor” takes care of chasing up customers and recovering them if necessary.

Throughout this article, we have shown that the accounts receivable represents a financial burden for the company. So any reduction in trade receivables improves your company’s cash flow and profitability. This should be your goal.

In addition, keep in mind that better managing your customer accounts also improves the image of your company. Indeed, rigorous management of your customer accounts does not break a commercial relationship, on the contrary:

  • Managing your accounts and following them up is an integral part of the commercial act
  • A customer satisfied with your services will respect a well-done professional follow-up

Finally, the follow-up contributes to the quality process of your company!

By aamritri

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