One of the most important lessons with respect to managing cash flow is this: The faster you collect from your customers, the easier it will be to manage your cash flow.
Most businesses carelessly fall into cash crunches because they let their receivables slip longer and longer before being paid. This puts your uncollected revenue in jeopardy and actually lowers your odds of collecting these outstanding receivables. Plus, the longer it takes to collect on what you’re owed, the higher your collection costs, which cuts into your profit margins.
What’s the solution?
The solution is to speed up your “collection cycle”. Your collection cycle is the average time it takes from the moment you have cash going out the door for “cost of goods sold” to the time you collect on the sale of that product or service.
For a manufacturer, this cycle starts when they buy raw materials to produce their parts and continues until three to four months later, when they collect from their distributors and other wholesale customers who buy their goods. As you can imagine, this ties up a tremendous amount of cash, which could otherwise be used to operate and grow the business.
Service businesses have collection cycles too. For them, it starts when they have staff time working on a project and material costs (both of which, comprise the cost of goods sold for a service business) and only ends when the customer actually pays for the service.
Far too many service providers make a sale, perform the work, and only then invoice for payment, often waiting thirty to ninety days to be paid after the work has been completed. In many cases, this means that the service business has had the cost of goods sold from labor, materials, and other out-of-pocket expenses to fulfill on its service offering for sixty to ninety days or longer.
Remember, the longer your collection cycle, the more operating capital you need to run your business.
Your goal must be to shorten your company’s collection cycle as best you can, which will free up operating capital to grow your business.
Here are 6 tips to speed up your collection cycle and collect more of what you are owed – faster:
1. Get paid in advance! The best way to reduce your collections cycle is to get paid up front. Getting paid before you fulfill your product or service helps you eliminate the hassle and additional cost of chasing down payment later. At the very least, collect a deposit, retainer, or advance.
2. Incentivize customers to pay in advance (if appropriate). You could offer a discount on advance payment, moving the customer to the front of the delivery line, or adding a bonus to their purchase they wouldn’t otherwise get. More customers are willing to pay in advance than you might think if you offer them an appealing incentive. Many business owners just assume customers will say no, so they don’t even ask. Don’t answer for your customers—ask them.
3. Don’t wait to bill; collect right at time of service or delivery. Ask for payment upon completion of the work or at the time you deliver the product to your customer. At the very least, give your customers a bill at the time the services are rendered as opposed to waiting several weeks.
4. Build a “cost” for your clients into your standard contracts. If you are financing your client’s purchases, then you should get paid for your trouble. Make sure your contract includes a monthly financing charge for all accruing bills. This clause should also state that the client is responsible for all reasonable costs of collection.
5. Accelerate your production and delivery cycle. Assuming your business gets paid in part or entirely after you have produced and delivered your product or service, then the faster you finish that production and delivery cycle, the sooner you’ll get paid.
6. Make it easy for your clients to pay. Accept credit cards, PayPal, and other online payment options. Set clients up on auto-pay through an ACH bank draft or credit card. Take payments by phone or through your Web site. Make sure your invoice clearly says to whom they should make the check out and for how much. Include a self-addressed envelope with your invoice. The easier and more convenient you make it to pay, you the faster you’ll get your money.
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