Accounts receivable (AR) is a common term in the business world that refers to the money owed to a company by its customers or clients for goods or services sold on credit. While having a strong AR balance can be a sign of a healthy business, it's essential to understand the financial risks and true costs associated with holding such balances.
Account Receivable Definition
First, let's understand the concept of AR. When a distributor sells goods or services to a customer on credit, it creates an account receivable. This means that the customer owes the distributor money, and expects to receive payment within a specified period, typically 30, 60, or 90 days. When the customer pays the invoice, the distributor records the payment in its cash account and reduces the AR balance.
One of the primary financial risks of holding AR balances is the possibility of bad debt. Bad debt occurs when a customer fails to pay their invoice, and the distributor is unable to collect the money owed to them. Bad debt can be caused by a variety of factors, including customer bankruptcy or business failure, and can have a significant negative impact on a distributor's bottom line, especially if they have a large AR balance.
The true cost of holding AR balances includes not only the risk of bad debt but also the opportunity cost of the funds tied up in the AR balance. When a distributor extends credit to a customer, it is essentially giving up the opportunity to use those funds for other purposes. This can limit the distributor's cash flow and ability to grow.
Another cost of holding AR balances is the cost of financing the balance. Distributors that offer credit to customers must finance the balance until it is paid. This means that the distributor must either have enough cash on hand to cover the AR balance or borrow funds to cover the balance.
Rather than looking for a business loan through a financial institution, many distributors turn to personal sources of funding to finance their business, including using their home equity or personal credit cards. While these options may seem like convenient and easy ways to obtain capital, they come with significant risks.
One of the most significant risks of using home equity to finance your distributorship is the potential loss of your home. If your business does not succeed and you cannot repay the loan, you may be forced to sell your home to pay off the debt. Additionally, using home equity to finance your distributorship may limit your ability to borrow in the future. If you need to access credit for personal or other business reasons, you may find it challenging to do so if you have already used up your home equity.
Credit cards are another common source of funding for distributorships. They are easy to obtain, and many offer rewards and cashback programs, making them an attractive option.
One of the most significant risks of using credit cards to finance your business is the high compounding interest rates. Credit card interest rates are typically much higher than other forms of financing, such as loans or lines of credit. If you are unable to pay off your credit card balance each month, you could quickly find yourself in a cycle of debt, which could be difficult to break.
Additionally, using credit cards to finance your distributorship may also negatively impact your personal credit score. If you are unable to make your payments on time, your credit score may suffer, making it more difficult to obtain credit in the future.
Strategies To Lower Financial Risks
To mitigate the financial risks and costs of holding AR balances, distributors can implement several strategies. The first strategy is to offer credit only to customers with a strong credit history and payment record. By vetting customers before extending credit, businesses can reduce the risk of bad debt and ensure timely payment.
Another strategy is to incentivize customers to pay their invoices early. Businesses can offer discounts to customers who pay their invoices within a certain period, such as a 2% discount for payment within 10 days. This can encourage customers to pay early, reducing the AR balance and freeing up funds for the distributor to use.
Finally, distributors can partner with ACS Affiliate Services to handle all of the financing of their orders. ACS allows distributors the freedom to pursue and fulfill any order of any size by ensuring suppliers are paid on time, so your orders are processed swiftly. ACS also tackles the fluctuating state sales tax regulations to make sure the taxes collected are filed and paid correctly.
A dedicated account coordinator frees up hours of your time and simplifies your daily processes by gathering supplier invoices and comparing them to purchase orders to check for accuracy. They then assist with invoicing and customer billing.
With ACS Affiliate Services holding the AR balances for your customer invoices, your personal and business capital is free to further market to your client base and invest back into your business and family.
In addition to lowering your personal financial risk, using ACS’s credit and capital eliminates the need for you to negotiate finances and payment terms- so you can focus on growing your business. This allows you to maximize your selling capacity and gives you the scalability and confidence to stay competitive in the marketplace to reach new heights with your business growth.
In conclusion, while accounts receivable can be an essential part of a business's operations, it's important to understand the financial risks and true costs associated with holding AR balances. By implementing strategies to reduce bad debt, incentivize early payment, or partnering with ACS Affiliate Services, distributors can mitigate the risks and costs of holding AR balances, while improving their cash flow and bottom line.
Reach out today to learn more about how ACS Affiliate Service can lower your personal financial risk and better manage your order-to-cash cycle.