Our previous PADGETT BUSINESS SERVICES® blog post explained in detail how to sharpen up your small business bookkeeping skills to figure out your company’s accounts receivable turnover, or ART. Remember, your ART is just a ratio that indicates how much money you have in invoices outstanding (i.e., not yet paid by your customers) in relation to the size of your business (in dollar terms).
You will recall that a higher ART is better, because it means that, on average, you collect on your outstanding debts relatively quickly. So why is this important?
OK, there’s a good chance that you didn’t actually ask yourself that last question, because every businessperson’s instincts would naturally say that getting cash in hand sooner is better than getting it later. Of course, that is correct from a business standpoint – but exactly why?
For one thing, the period that it takes to collect accounts receivable is one of the purest illustrations of the saying that “Time is money.” Or rather, the longer that your money spends out of your control, the more the situation can cost you. Here we are not necessarily talking about a direct expense, but what’s called an opportunity cost – basically, alternative ways that you could be using the money during the interval it takes customers to pay.
Say, for example, that two customers owe your firm the exact same amount of money -- $1,000. Customer A eventually pays within your 15 day terms, but Customer B takes 60 days to remit the thousand to you. What could you have done with that $1,000 in those 45 days? Whatever other use you could have put the money to is your opportunity cost.
Opportunity costs can have a value much higher than the debt itself, because unpaid debts reduce your available capital. Without that $1,000, were you perhaps unable to buy a new piece of equipment that would’ve improved your efficiency and boosted your bottom line? If your cash flow is poor enough, the ultimate cost to you could be the very survival of your business!
Having a low ART can also cost you the opportunity of getting a small business loan, which could prevent you from upgrading your facilities or expanding your enterprise. You might not be able to take advantage of growth opportunities, or even to stay competitive – again, endangering the existence of the company you worked so hard to build.
Be forewarned that if you plan to apply for a loan, potential lenders will be interested in your ART (among many other financial details of your company!) A low ART gives lenders less confidence that they will ultimately be repaid by you. From the bank’s point of view, the longer one of your invoices has gone unpaid, the greater the chances that it will never be paid.
Outstanding invoices are considered assets of your company, but only to the extent that you can reasonably expect to collect on them. Next up in the blog, we’ll talk about how to get paid more quickly!
PADGETT BUSINESS SERVICES® provides small business financial planning assistance that can make your company’s future more clear and more secure. Padgett also offers tax planning and preparation, payroll services, small business consulting and more. With Padgett’s “small biz pros” working for you, you’ll be able to worry about your business less and focus on what you do best!