In this chat, we'll discuss whether you should have accounts receivable (AR) and accounts receivable collection procedures so you stop providing interest free loans to your clients and customers.
As a freelance bookkeeper, I learned the hard way that I am not a bank or finance company. This is going to be a hard story to share ... it kind of makes me feel like you are seeing in me in my underwear :0( ... but I'm taking a deep breath and here I go.
I lost thousands of dollars when I first started out because I was too shy to actually ask for a deposit up front. I was keen to do bookkeeping and get my business up and running ... after all I had bills to pay.
I purchased a business from a bookkeeper who turned out not to be completely honest. (Don't even go there with me ... the person seemed honest and genuine and I never thought a bookkeeper would be duplicitous ... which is why I am big on internal controls because you never know.)
The business did not have the consistent cash flow purported (only one of the things the previous owner was not forthcoming about ... and no I won't tell you how he fudged the records to make it look like there was regular monthly cash flow) and the clients I inherited were used to being offered credit, not paying upfront.
Between rent, payroll, and the business loan to purchase the business, there was not enough money left over for me to take a draw. (I did factor in a regular draw for myself when I put in my offer to purchase the business.) As a result, I often ended up on my parent's doorstep mooching dinner. Good thing they liked having my company! :0)
It took me two years to dig myself out of the hole and reach break-even ... well sort of ... the business still wasn't supporting me. I was living off my parent's generosity and my RRSPs. I ended up closing my business to take a contract up north so I could pay off my remaining business debts.
In hindsight, at times, I wish I had stuck it out ... but not being able to pay my bills makes me anxious. When I decided to start up my bookkeeping business again, I decided I would not accept credit ... I was NOT going down that road again. I like to think of it as learning from my mistakes ... which all small business owners know is necessary when running a small business ... because mistakes will be made.
Make a mistake ... learn from mistake ... adjust procedures to put lessons learned into effect ... this is the recipe for success.
Based on my personal experience, I recommend that all small businesses NOT grant credit. I recommend accepting cash, credit cards, or PayPal only but ...
If you do offer credit, it is extremely important to monitor your accounts receivable. You will find two AR ratios that may be a useful tool for you in Basic Ratio Analysis.
In Stephen L. Nelson's book QuickBooks 2009 for Dummies, he gives a bit of advice on accounts collections procedures. Here is what he recommends.
Universal Accounting's The QuickBooks Specialist Newsletter (it's free to subscribe) suggests these techniques to ensure you get paid:
A direct benefit to you as a business owner is it gives you a method
to verify that all the receivables are valid and that the sale(s)
actually occurred ... a good internal control procedure to reduce the
likelihood of fraud.
I read an excellent article by Gary Barzel titled Using Your Accounting Software For Effective In-house Debt Collection. He explains that when selecting your accounting software, make sure it has the following features:
Setting up accounts receivable collections procedures like the ones above are part of designing your accounting system.
I learned something new while attending an IPBC webinar ... don't you just love that!
According to the Income Tax Act (sorry don't have a reference), you cannot write-off a receivable unless/until you have made a real effort to collect. Be sure to document the steps you went through to try and recover the debt.
While you are working your receivables, remember to adjust your accounts receivable collections procedures to require a deposit up front ... at least for your new customers/clients and the current ones on your AR list that you are busy working. :0(