Critical Business Functions: Misunderstood, Underutilized, and Undervalued Part Two: Closing the Circle of Credit and A/R Management

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Critical Business Functions: Misunderstood, Underutilized, and Undervalued Part Two: Closing the Circle of Credit and A/R Management
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In the past, the idea of credit clung to the philosophy of risk management, measured by Days Sales Outstanding (DSO) and percent of bad debt. However, credit and effectively managed accounts receivable (A/R), when used as a sales tool can generate huge returns by motivating sales. By looking at the major components of credit-to-cash function, and giving each component a goal, companies can increase sales and improve cash flow while controlling losses and costs. Using updated reporting techniques, understanding the competitive landscape, and using appropriate A/R management software will help companies realize a notable return.

This is Part Two of a two part note.

Part One detailed the background and main components of credit and A/R management.

Part two will discuss measuring and improving credit and A/R management.

Monitoring and Improvement

The circle of credit and A/R management is closed when companies continuously monitor and improve each of the key steps in the process. Goals need to be established. Actual results need to be measured and compared against these goals. Opportunities for improvement need to be identified and changes made. Finally, new goals are established and information gathered to monitor the revised processes.

Please keep in mind that this is both an internal and external process. The internal component is an analysis of the efficiency and effectiveness of various credit and A/R management business processes themselves as well as individual employees (or work groups). Efficiency is tied to the cost of a business process (or one of its components), while effectiveness is tied to whether the specified goals are being achieved. You could spend great quantities of cash making a business process work, but that would not be cost effective. Conversely you could reduce costs but not achieve the required goals. Somewhere between these two extremes is the best suited path and that path will depend on your industry and the way you have decided to run your business.

What then needs to be measured and why? The following list is certainly not all inclusive but is intended to help establish a framework to measure efficiency and effectiveness.

Payment Terms: Cash flow can be impacted if payment terms are too liberal. While more lenient payment terms may be a reflection of competitive realities, they may also be used as a quick fix to gain business.

Invoicing Delays: If there is a delay between the time an order is shipped or a service provided and the invoice date, this may be an opportunity for improvement. Users should track both the average delay (general improvement) as well as investigate billing delays for specific invoices that exceed a specified limit (specific improvement).

Procedural Errors: The failure to meet a customer's business process requirements (purchase order number, invoice formats, pricing, even number of invoice copies) will lead to payment delays. These procedural errors need to be segregated by type, tracked, and continuously improved.

Service Disputes: If a customer does not pay on time due to an identifiable dispute or problem (goods or services are not provided on time, poor quality, or any other reason that can be tracked), cash flow will be negatively impacted. These specific problems need to be resolved as quickly as possible (another measurement standard) and they need to be tracked over time to determine if general improvement is being achieved.

Average Days Late: Average days late (ADL) measures a customer's payment history as it relates to the payment terms offered for each invoice. If a customer's ADL is increasing or is higher than average, this should be a trigger to contact the customer, not about a specific invoice, but their payment history in general. ADL may also indicate that a specific A/R representative is not quite as effective as they could be (when compared against other A/R reps). Finally, payment history should be one of the factors sales people consider when discussing future pricing with customers.

In each of the examples above, progress will be made only if identified problems are addressed immediately. This isn't the only solution though. Statistical and historical information need to be collected and tracked. For example, when an invoice becomes overdue, A/R reps need to determine both the classification of the problem (maybe this time it is a procedural error) as well as its specific subcategory (failure to indicate customer purchase order). By tracking the underlying causes of payment delay management can determine where they need to focus its attention and whether these problems are being improved over time.

Replacing Aging Reports

In the past and to some extent even today the only A/R management tool available was an aging report. While the aging report does list overdue invoices, the contact and follow up process is entirely manual. This may be acceptable for companies with a limited customer list or limited invoice activity, but it is certainly inefficient and ineffective for everyone else.

Improving the invoice-to-payment process must start with the assumption that the aging report as the primary management tool must be replaced with a software-supported process. Specifically the process should mimic the functions found in a contact manager.

While there is no doubt that bringing receivables under control will initially require some effort and expense (mostly time), the goal is getting customers to the point where they are thinking about you when selecting invoices for payment. If you can reach that point with most customers, the future time and cost required to keep receivables in line will be more reasonable.

Ultimately, your approach has to be positive, not negative. "He who screams loudest gets paid first" does not work in the long run. Threatening customers does not contribute to repeat (highly profitable) business. You want them to give you payment priority because they want to, not because they have to.

Competitive Landscape

Although the return on investment (ROI) for A/R management software is extremely high (500 percent and more), very few middle market accounting software vendors offer this application either directly or as a third-party product. Navision (third-party), Great Plains (direct), SouthWare (direct), Solomon (third-party), and Syspro (direct) however, do offer this functionality. Navision's application is by far the most comprehensive. There may be other third-party products that integrate with middle market accounting products, so the best course of action is to ask your vendor or reseller.

A/R Management Software

If the goals of A/R management are best served by a supporting software application, what features are most important? It will not be possible to describe every function or associated business process, but we will try to highlight the most important aspects.

  • Responsibility: Specific collections responsibility must be assigned to people within the organization. No business process will achieve optimum performance levels unless people are actually assigned responsibility and their performance measured. In some cases responsibility can be shared between two or more people in a work group setting. If required, individual customers should be assigned to specific A/R management representatives. This fosters a positive relationship by which subtle pressure can be applied just as it is in the sales process.

  • Sales Reps: In some cases sales representatives can be brought into the process with full contact responsibility or with read-only access (meaning they can view a customer's payment history, but cannot actually record collections calls).

  • Hierarchy: Some form of hierarchy should be created to facilitate management oversight as well as the transfer of responsibility. A prime example here would be the transfer of responsibility for an invoice from a collections rep to the CFO or other senior manager if legal action is the next logical step.

  • Trigger Points: While dates drive a typical contact manager and certainly dates will drive an A/R Management application once first contact has been made, the trigger that will drive the first contact with a customer (concerning a newly identified overdue invoice) will be an event. Smaller companies could get by with a very limited number of event types, while larger organizations may want to take full advantage of the fact that any one of several event types could drive the first contact. In most cases the trigger point should be based on due date + |x| days. For example, an invoice will be passed through to the A/R management application five days after the due date. Users should also have the ability to define customer-specific trigger points.

  • High Value Invoices: A separate trigger point could be assigned to invoices that exceed a certain dollar value. This recognizes the fact that high-value invoices should receive higher priority.

  • Statements and Dunning Notices: We have assumed to this point that the driving force behind the A/R management system is personal, repetitious contact with customers. What about statements and dunning notices (letter and e-mail)? This is certainly the least costly alternative, particularly if e-mail is utilized as the delivery vehicle. The problem is that statements and dunning notices do not work in all instances.

    If an invoice is incorrect or lost in the mail, good customers will respond to a statement or dunning notice. Other customers will do nothing simply because it's not their problem. Some customers are "too busy" to take notice. This is particularly true for companies in which the invoice processing function is not efficiently organized. Customers that cannot pay on time or elect not to pay on time as a matter of policy will ignore any form of faceless communication.

    The conclusion that we can draw here is that statements and dunning notices will work under a limited set of circumstances. The most significant drawback is that when this alternative does not work (and that could be most of the time) it delays payment even further. If a customer responds to dunning notices, then it makes economic sense to utilize that as the first contact. If a customer does not react to dunning notices, then the first contact should be personal.

  • Call List: Each person responsible for collections will open the equivalent of a call list just like they would in any contact manager. All newly overdue invoices would be assigned the current date. All other invoices would be sorted by next contact date, again just like a contact manager. Although calls should be made based on next contact date, users should have the flexibility to sort the call list by customer, invoice amount, or any other field associated with the call list.

  • Contact Manager Screen: Once an invoice is selected, the system will display the contact screen and this is where it becomes necessary to have a specialized application. Users should be able to access, via smart buttons and lists every piece of information that will facilitate the payment of this invoice. The user does not have to specify customer ID, invoice number, etc. Once a call has been completed, contact notes recorded, and promised payment date solicited (this is a critical step), the user will record the next contact date (usually a few days after the promised payment date). Hopefully the initial contact will encourage the customer to settle the account by the promised payment date, but if required, users should be able to record an unlimited number of contacts, share this file with other people (even if that is just to cover vacation time), reprint invoices and statements, access e-mail from within the application, and even pass responsibility to another person.

As you can see, many of these functions are identical to those available in a contact manager. However, you can also see that users need to access multiple sources of information and multiple functions that are very specific to the collections process.

Systematic and repetitious contact over time helps the customer realize that you will not let them extend payment. They, in turn, will extend higher payment priority (pay you more rapidly) and that is the primary goal. The customer-specific and invoice-specific information and functions make the process more efficient. Both goals must be achieved.


Accounts receivable can represent the single most valuable liquid asset any company possesses. A modest reduction in A/R can generate a huge one-time cash flow and yet many companies and certainly many accounting software vendors do not seem to understand the potential business benefits of credit and A/R management.

We have to be careful what we ask for. Keep using DSO and percent bad debt to measure the performance of your credit function and what you will get is risk management. Tell your people that they are "collectors" and you shouldn't be surprised if they go out and get a tattoo or have a body part pierced and come back with an attitude.

On the other hand embrace a credit management philosophy that seeks profitability, that defines credit as a sales support function and you can expect more new sale, more repeat sales, higher customer service levels, improved customer retention, and by tracking the source of type 2 systems problems, where customers have either short term or long term monetary problems, constant improvement in your business practices.

Rather than assuming your current A/R management processes are adequate, run the numbers. Examine your approach. If your credit policies and practices are oriented toward risk aversion and are also negatively charged when dealing with customers, consider a more positive approach that encourages customers to improve their payment history.

If your A/R balance is on average ten or more days above your typical payment terms, then you need to investigate some form of software-assisted A/R management process. If your business management system does not provide such an application either directly or as a third party product, investigate the ROI for creating one. Your vendor or reseller may even be willing to partner with you, reselling the application to other users.

The key to an effective credit and A/R management process is treating it as if it were an integral part of customer relationship management (CRM) which in fact is precisely what it is. The people who control payment processing are just as much customers as those people who make the initial purchase decision, and the last thing you want to do is give your customer a reason not to buy (or in this case not to pay).

About the Authors

Charles Chewning, Jr. is president of Solutions, a Richmond, Virginia-based (US) consulting firm specializing in accounting software selection. He is considered a leading software selection expert. Chewning has written a number of accounting software reviews and is a frequent speaker on the subject of accounting software selection as well as sales and marketing. He is the publisher of The Accounting Library (

He can be reached at

Abe WalkingBear Sanchez is the president and founder of A/R management Group ( and developer of the copyrighted Profit System of B2B Credit Management. An international business speaker, WalkingBear has spoken to over 600 CEO and top managers groups worldwide in the last ten years.

WalkingBear can be reached at

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