Managing your debtors is one of the first cash flow strategies that I look at when working with a business. Dealing with unpaid accounts is not fun. However, not managing your debtors could be costly even deadly to your business.
Inflated debtors lead to inflated $200,000 profit
A few years ago I was asked to help an overseas client. They thought things were ok. They wanted someone to tidy up a few loose ends before hiring a new Finance Director. The financial reports showed they had a great year. A profit of over $200,000. However, when I ran my cash flow template over their accounts I noticed there were some major issues.
The first thing that stuck out was the accounts receivable. The Aged Debtors report highlighted they had over $200,000 in 90 days outstanding.
Going through the outstanding debtors one by one, I found some problems. Some customers were sent invoices twice. Other customers were billed for services that they were never provided. This meant their revenue was inflated. This made their profit higher than it really was. I also found that some debtors had left the country which made the recovery of the money near impossible.
Poor information leads to poor decisions
The large profit the business thought it had made was gone. What made the issue worse was the fact the management had made decisions based on the original profit. They had committed money for different projects.
This is an example of what happens when you don’t track your debtors. If your accounts are wrong and you could be making bad decisions because of poor information.
Another consequence of not managing your debtors include paying too much tax. For example, in this situation by overstating your income by $200,000 you will pay $60,000 in company tax at a rate of 30 cents in the dollar. I have seen this situation a number of times.
Three action steps to start today
- Review regularly – Choose a day a fortnight or week that you will review your Aged Receivables report. Always review on that day without fail.
- Set a warning signal – Have a warning number set up. So you can easily know if your debtors need tighter management. For example, if your terms are 30 days then divide your annual sales by 12. $1,000,000/12 = $83,333. Your goal is to have your debtors less than $83,333. Above this figure and you start taking action.
- Review your system – Prevention is always better than cure when managing your debtors. Make sure your system is solid and being followed. If there is something you don’t like doing then hire somebody else to do it.
That’s all for today’s blog. Remember to regularly review your debtors especially before sending your final accounts to your accountant. You don’t want to be paying more tax than you have to. This strategy is from the e-book ’10 Cash Flow Strategies for a Successful Business’. (Click on the link if you haven’t already downloaded the book).