Good management of trade receivables is a major challenge for companies. Customer risk has a direct impact on a company’s cash flow and working capital requirements. In this article, we offer you a complete guide to trade receivables, to help you understand how they work and how to optimise their management.
What is a trade receivable?
A trade receivable is a sum of money owed by a customer to a company that has supplied them with a good or service. In practical terms, the amount owed is a receivable for the company, which has a right against the customer, whereas for the customer, the amount owed represents a debt. This sum becomes a receivable when the invoice issued has not yet been paid. Customer receivables are therefore recorded as assets on the company’s balance sheet, since they are a resource. Company debts, on the other hand, are entered on the liabilities side of the balance sheet.
How do you value trade receivables?
It is essential to evaluate trade receivables. Even if the collection of a sum owed by a customer is foreseeable from the moment the contract is signed, many factors can delay the moment when it is actually collected. For example, the time taken to provide the service or the delivery date may come into play. Similarly, the payment period granted to the customer to pay its invoices can postpone the moment when payment is made.
Added to this is the risk of unpaid invoices. Trade receivables are expected inflows for the company. Excessive delays in the payment of invoices can therefore have a negative impact on the company’s cash flow. There is also a risk of an increase in working capital requirements (WCR), which can be costly for the company if it has to finance it through short-term borrowing.
To assess trade receivables, it is advisable to monitor two indicators: outstanding trade receivables and days sales outstandings. Outstanding receivables correspond to the sum of invoices to be issued, unpaid and overdue. Average payment terms, or APT, can be calculated for all customers or for a specific customer. It enables us to understand customer behaviour and anticipate it more effectively. DSO is calculated as follows: DSO = customer receivables over a defined period / (sales x number of days in the same period).
What strategy should you adopt for proactive receivables management?
To limit the financial risks associated with trade receivables, you need to adopt a proactive approach. This involves:
- the introduction of a clear and precise credit policy that sales staff can easily apply when drawing up contracts;
- the adoption of clear terms of payment which are included on all documents (general terms and conditions of sale, contracts, quotes, invoices, etc.), to avoid disputes with customers on this subject;
- the application of reminder and collection techniques that are relevant to customer profiles and amounts owed;
- the use of tools and software for the collection of trade receivables that provide real-time information on the situation.
How do you prevent overdue payments?
Finally, controlling the level of trade receivables also requires effective management of unpaid debts. Good debt collection involves analysing the creditworthiness of customers in order to assign them a score. Depending on the customer profile, the company can apply different payment terms to limit the risk of non-payment. Next, the drafting of contracts and guarantees is essential. It is also essential to monitor customer accounts on a regular basis, both in terms of accounting and sales.
Conclusion
Trade receivables therefore include all sums owed by customers to a company, regardless of the status of the invoice. Good control of trade receivables helps to maintain a balanced cash position and limit working capital requirements. It is therefore essential to be proactive in managing trade receivables. To achieve this, the use of collection software that provides access to personalized dashboards updated in real time, such as CashOnTime, is a real asset.
