Risk is inherent to each and every business process, but in the accounts receivables, excessive risk creates big downstream problems. Cash flow, client relationship, performance, and more all depend on your collections processes. As such, a rigorous accounts receivables risk assessment process mainly helps you to identify potential areas that may trip you up over time. This will help you manage the delinquency and asset classes.
So, below are some of the tasks that you can do to complete a risk assessment of your accounts receivables and secure your cash flow at the time of economic uncertainty.
Sort your customers into groups
Sorting your customers into groups will help you to identify patterns and establish a higher risk profile. Each group may require a different management strategy and continuous assessment. It is important to understand that customer classification into asset classes is not static and the customer risk keeps on changing from time to time and has varying sensitivity to external events.
Limit your exposure to bad debts
To identify which customers pose a greater risk to your cash flow, it is useful to identify and list what security arrangements and guarantees your business uses. These may include the:
- Factoring
- Lien
- Credit insurance
- Comfort letters
- Bonds
- Transfer of assets
- Transfer of receivables
Calculate DSO – Days Sales Outstanding
The average time in terms of days between both the payment and invoicing is your DSO and is a good indicator of the efficiency of your receivables management.
To calculate your DSO, first of all, you need to divide your total accounts receivables by the total value of your credit sales. Then just simply multiply this figure by the number of days in the period you are assessing. Many businesses used to calculate their DSO on a regular basis, monthly, quarterly, or annually.
Complete an aging report
An aging report is a table that helps you to record your accounts receivables according to how long each invoice is being outstanding. An aging report will help you to identify how long individual customers are taking to pay.
Assess the effect of your payment terms on your accounts receivables
Make a highly critical assessment to find out if your payment terms meet your company requirements or if they need to be adjusted. Additionally, many individual clauses can result in too many variations and even lead to delayed payments. You could even try to seek to reduce the number of clauses in your payment terms or find ways to enhance their attractiveness, that is, with the help of payment incentives like discounts, bonuses, or periods of payment.
Enhance the skills of your credit management team
The risk of high loss can be easily reduced by skilled credit managers and relates staff. In times of economic stress, such as the current situation which is caused by the COVID-19 pandemic, you can help protect your company cash flow by appointing a team dedicated to monitoring your accounts receivables through weekly reviews and empowering the team to act quickly.
Collection Effectiveness Index (CEI)
Put most simply; the CEI compares how much money was owed to the company and how much of that money was actually collected in the given time period, usually one year. The resulting percentage allows the company to gauge how strong their current collections policies and process are and whether or not changes need to be made.
CEI= (Beginning receivables + Monthly credit sales – Ending total receivables) / (Beginning receivables + Monthly credit sales – Ending current receivables) x 100
Number of Revised Invoices
Keeping track of invoices that have been revised or disputed and the reasons could help you to identify further areas for improvement.
It could be something as simple as adjusting the layout of your invoice to make some of the information more apparent or considering accepting a different payment method.
You can even look for patterns in the type of customers that dispute invoice, the challenges which they have, and how they were resolved and use this to help shape your new strategy going forward by addressing potential issues upfront and better predicting accounts where there may be an issue down the line.
Credit Risk
Corporations can reduce credit risk by assessing the customer’s portfolio and separating those who have a history of paying on time from those who are late payers. The company can then implement different limits and collection strategies for the late payers. Companies can even request a customer’s credit report to see their credit history and credit rating. They can use this information to create credit limits and terms for the customer to reduce credit risks.
Average Days Delinquent (ADD)
Average Days Delinquent is how many days on average payments are overdue and can be a warning sign to problems. If the number is high, then you need to determine whether your systems, invoice, and collections processes need improvement. ADD is calculated as the DSO minus your actual average terms. Over time, measuring the ADD and DSO will show you whether you are improving, falling behind, or static.
Percentage of High-Risk Accounts
Doing business with higher-risk customers is neither good nor bad. It should be a part of your business strategy. Do you have an excess of depreciating inventory? Do you need extra market penetration in a territory? Many industries are inherently ‘high-risk’ so that the credit and sales managers are aligned and have to do what they can to offset the additional risk with the credit instruments and, perhaps, pricing or terms.
Track It All with Intuitive all in one Dashboard
The very next step is improving accounts receivables performance to implement intuitive dashboards to the traditional financial reporting process. Once you start tracking the analytics and metrics that matter, those insights then need to be available to all the stakeholders across the enterprise. The dashboard offers users a glimpse into account receivables performance by combining visualizations, metrics, and intuitive tools into one interface.
Get AI-Powered automatic customer classification tools
Several tools use deep learning algorithms to classify the customer based on trends of payments and delays. Once such a tool is FETCHMYPAYMENTS . Rarely does a customer suddenly goes delinquent. The signs of debt getting bad are embedded in the payment trends, no matter how subtle those signs are. The deep learning algorithms are trained to read those signs and alert you about those signs so that you can take corrective actions.
