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Financial Aspects of Accounts Receivable Management:
With that being said, in each company success was achieved in managing accounts receivable and managing the customers which in turn provided increased cash – yes increased cash which in turn allowed the business to operate and prosper.
The best example is the Internet business. The original management team did not manage. Annual revenue was $9,000,000. EBITDA was $1,600,000 (18%). Interest expense was $600,000. Account receivables (net of service charges assessed) averaged $2,500,000. The company’s banking relations were maxed out. Financing was provided by extending vendor invoices resulting in financing costs of 18%. Quick analysis of the situation was:
1. Accounts receivable turnover = 3.6 times – average in the industry was 8 times.
2. Average age of accounts receivable = 101.4 days – sometime in the 4th month the customer paid.
That was the quick look. The reality was that roughly 1/3 of customers were immediate pay (assume same as cash). The revised ratios became:
1. Accounts receivable turnover = 2.4 times
2. Average age of accounts receivable = 152 days – sometime in the 5th month the customer paid.
Through a lot of work and negotiation – mostly internally we were able to change the account receivable process such that on average, credit customers paid in 35 days. We lost $450,000 in revenue (customers that were accustomed to extended credit left and customers that never paid were terminated). We were only able to reduce operating expenses by $130,000 causing our EBITDA percentage to drop to 15%. Account receivables dropped to $400,000 – a $2,100,000 reduction. The opportunity costs (18%) of the $2,100,000 resulted in a drop of interest expense of $380,000 ($2,100,000 x .18). Overall the company realized a $60,000 increase in profits, better quality of customer revenue and better relations with vendors.
The last benefit was that we were able to increase the company’s cash turnover rate by the reduction in accounts receivable of 89 days that reduced the minimum operating cash requirements for the business.
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