How to Improve Your Receivables Position With Better Risk Analysis

When it comes to reducing Accounts Receivable risk, that old saying “a stitch in time saves nine” holds true.

If you drive a car then you know what a dashboard is. There are two main gauges that we are all very familiar with – the speedometer and the fuel gauge.

When it comes to reducing Accounts Receivable risk, that old saying “a stitch in time saves nine” holds true.

If you drive a car then you know what a dashboard is. There are two main gauges that we are all very familiar with – the speedometer and the fuel gauge.

The other gauges we don’t usually take much notice of. It is a similar story if you are running a business – the speedo is revenue and the fuel gauge is money in the bank, and it is those two measures most businesses keep an eagle eye on. The other gauges are important, but only if they start to move. If they do start to move and you don’t do anything about it, then the outcome can be catastrophic. When you think about the temperature gauge on your car dashboard, then like me you are probably aware of it subconsciously.

You know it moves up when you first start the car until it reaches the normal operating temperate, and then it doesn’t move from that level. If it does start to move further it usually doesn’t take you long to realise something is not right (maybe you need to top up the coolant, for example). If it returns to normal and stays there then all is good, however if it starts to rise again you know that you have a problem, and if it is a rapid rise then you have a major problem.

There are a number of basic business functions that could do with a temperature gauge (and one with a few more levels of sophistication). One of those business functions is Accounts Receivable (or Collections).

When you think about your receivables, a simple temperature gauge-type indicator is probably not going to cut the mustard, because by the time it starts to move it is probably too late to take effective action. In addition, you really want to be able to drill down to more detail and see the gauge for individual debtors/customers. In theory, a high receivables number is a good thing but not if it is all owed by one of two customers and they haven’t paid you for the last 90 days. You need to be able to easily see this. When creating your Accounts Receivable dashboard there are some great indicators that we recommend you incorporate:

Spark Lines – These visual prompts let you easily see the history. In the case of the example to the left, we see this particular customer in the past had traded well with little or no amounts in the over 90 days outstanding until recently, where it has risen rapidly. As soon as you see this spark line you can see you have a problem and you would take action immediately.

Data bar – This visual is excellent to show you where one customer is in relation to others. A quick glance and you can see the problem. In the example, all the customers are over their credit but Kapiti Electrical is by far the worst offender. Using an indicator like a red X is also a very effective way to make offenders who have exceeded their limit stand out.

Ageing Buckets – As previously mentioned, having receivables is a good thing; having them outstanding for over 30 days is not so good. So being able to see your receivables profile broken down in days outstanding is extremely useful. In the example we have also shown the variance % in relation to the position last year and color coded this to again make it easy to spot and understand. The profile allows you to snapshot your exposure risk and the variance shows if you are getting better or worse at managing that risk over time.

Drill down and Slice ‘n’ Dice – Keeping with our analogy, if your car temperature gauge does start to rise or is in the red, then the next step is usually to look under the hood to try and find the problem cause and solution. You need this same ability from your Accounts Receivable dashboard. If you see that
your 61 -90 days exposure is rising, you need to be able to drill down on that number to find the reason – is it just a few problem customers or is it across the board? Maybe you need to slice it a different way, for example is it just related to a market sector, like Resellers, or a region, say Pacific? If that was the case you would really want to focus in on any of your Pacific customers who are Resellers.

Trends – Graphs are great tools that allow you to simply and easily convey a lot of information that can be instantly understood. Trend line graphs have the added advantage of showing you performance over time, and by adding color you can easily get more insight. In the example, the colored trend lines allow us to easily see how we are performing. We should be really concerned about the trend in our 61-90 days outstanding receivables, and although in the last month it has started to go down this corresponds to an increase in the over 90 day outstanding. So all that seems to have happened is the 61- 90 days hasn’t been collected and has rolled into over 90 days outstanding. That is not good news and should be given urgent attention.

Alerts – These are like the flashing lights on your car dashboard activated when something has been exceeded, the oil level is too low, it has been too long since the last service etc. In a good Accounts Receivable dashboard you should be able to set up alerts. For example, if a credit limited is exceeded or likely to be exceeded then an alert (say, email) is sent to the appropriate person to inform them of this, allowing them to take some pre-emptive action.

Benchmarking and Ratios – While internally useful, they are often used by external parties such as auditors, bankers, shareholders and investors to determine the health and risk of your company. One key ratio often used for receivables is Days Sales Outstanding (DSO) – this is the total of your receivables divided by your average daily sales to give you your day’s sales outstanding. The lower that number, the better. Internally, this ratio is important as it affects cash flow, the requirement to borrow and net profit. Externally, it is something your auditors will look at and, if high, will be noted as a risk and therefore can impact share price/shareholders and make it harder or more expensive to borrow. Those same external organizations will use these ratios to benchmark you against similar companies, so it is often prudent to benchmark yourself and see how you rate against similar companies.

When it comes to reducing Accounts Receivable risk, that old saying “a stitch in time saves nine” holds true. If you can easily see a problem or what could potentially be an emerging problem and then quickly act to resolve it, you can save a lot of time, effort, resource and money. To do this, however, you need the information in front of you in a format that is easy to understand and interpret.

This is where a good Accounts Receivable dashboard (as in the example) is invaluable. It allows you to quickly spot potential issues and quantify those issues. By drilling down into the detail you determine the reason for the problem, and by slicing and dicing you can see if it is an isolated problem or affects a particular customer or market set. A good dashboard also allows you to track your performance over time.

The value of being able to do this can have a significant positive impact on your business. For example, a significant reduction in Days Sales Outstanding will have a huge positive effect on cash flow for which the knock-on effects can be immense.