Two tools to help you stay on top of unpaid invoices and protect the cash flow that fuels your growth.
"A/R" stands for Accounts Receivable. In other words, you've invoiced somebody, but they haven't paid you yet. With just a handful of clients, it's easy enough to keep track of who still owes you money—smaller businesses or those in other industries (e.g. direct to consumer) may not even use Accounts Receivable. But as your business grows, and your number of clients grows, your Accounts Receivable is going to become a big ol' thing.
Ten clients have thirty-day terms; eighteen clients have sixty-day terms; another client has sixty-day terms but regularly pays thirty days late. Keep track of all those due dates, terms, and payments with your Accounts Receivable spreadsheet or software (e.g. QuickBooks).
Your Aging A/R spreadsheet is exactly what it sounds like: it's for those invoices that are past due. They're getting wrinkled and old! They need your prompt attention!
You need to actively manage your Aging A/R; there's no room for passivity here. Some clients may genuinely forget to pay you and need your reminder. Some clients may play games, trying to get sixty-day terms instead of thirty by simply not paying you until they're thirty days past due. These wayward clients can affect your cash conversion cycle if you don't stay on top of them, hindering your ability to grow the business.
One handy little tool works with your Aging A/R: the Days Sales Outstanding number. The DSO tells you the average number of days it takes for your company to collect payment after a sale has been made.
The Aging A/R lists all the past-due invoices.
The DSO measures the average number of days your clients take to pay you.
If you're using an accounting system like QuickBooks, your Aging A/R will have data on every customer who's late, along with how many days they're late. QuickBooks can run a report, aggregating all that tardiness data:
The lower your DSO, the better able you are able to grow confidently and not be at risk for growing faster than your cash. For non-retail-based businesses, under thirty days is best practice, in our opinion. However, if you work with bigger clients who command longer terms—say, Walmart-type with ninety-plus day terms—that will extend your DSO. Use this number to measure performance and stay on top of your Aging A/R.
Can you see why implementing financial cadences is so helpful? Regularly checking in on these numbers is a critical practice for the bootstrapping entrepreneur. If you don't religiously monitor invoices, some customers may pay you ninety days late. Other customers would be happy to never pay. In any case, that puts a major strain on your cash. And—have we said this enough?—cash is the lifeblood of your business.
Not only do these cadences help keep cash in your bank account; they also help drive discipline and accountability. For instance, in our start-up days, monitoring cash was a team effort. Christian did the invoicing and a lot of the follow-up cash collecting, while I did the bookkeeping. Our joint review of these numbers prompted regular meetings that helped us make solid thirty-, sixty-, and ninety-day forecasts on our cash flow and accounts receivable. That kept us accountable with handling finances, and it also kept us accountable to our business plan, ensuring we were playing off the same sheet of music. That's Good Business.
As a final point from experience here, proactively managing A/R is one of the top ways that we have been able to confidently and predictably bootstrap fast growth. It is so important that we have often tied compensation incentives for the person responsible for managing our A/R. We consistently operated at sub-30 days DSO for years, and though it felt like a good number, we didn't realize that it was three times better than typical firms in our industry until a financial consultant told us. Small tweaks like that, in aggregate, help to form a hidden back-office competitive advantage, and that enables other parts of the business to operate better. These small things add up over time!
By doing a little numbers-crunching, it's possible to see just how much it adds up. Check out the impact to cash flow in reducing DSO from ninety to thirty days on a $10 million annual revenue business. You can use these same formulas to calculate the impact on your business' cash flow—just swap out the variables with your actual numbers.
This is one of many measuring tools we share in The Good Business. Grab a copy to get the complete framework for bootstrapping a business to $10M and beyond.
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