What is a trade receivable? How to master the collection process? Let's discover together all the best practices for managing trade receivables.
What Is a Trade Receivable?
Trade receivables represent the sums owed to a business by its customers for the goods or services it has provided. For example, if you are a shoe manufacturer and sell about a hundred pairs to a store on invoice with deferred payment, that invoice becomes a receivable in your accounting until the customer pays the invoice.
At this stage, it is worth noting that the term "debtor" is used to designate the customer who owes the amount indicated on the invoice, while the "creditor" is the company waiting for the payment.
Trade Receivables in Accounting
Trade receivables play a crucial role in accounting. They are recorded as an asset on the balance sheet, more specifically in the "Financial fixed assets" category.
When a business delivers a good or provides a service, account 411 is immediately debited. At the same time, account 70 is credited to reflect this transaction.
If the customer exceeds the payment terms without having settled their debt, it is then necessary to adjust the accounting entries. In such a case, account 411 is credited, while account 416, dedicated to payment delays, is debited. This action ensures that the accounting accurately reflects the financial situation of the company in relation to its customers.
How to Properly Manage Your Trade Receivables?
Effective management of trade receivables is a vital element for the financial health of a business. It essentially involves monitoring and controlling customer payment terms to maintain a healthy cash flow and minimize the risks of payment default.
A Goal: Mastering Your Working Capital
A key element in managing trade receivables is mastering working capital. Working capital represents the amount of money needed by a company to finance its operating cycle, that is, the period that elapses between the time the business invests money to produce and sell goods or services and the time it receives payment from its customers. High working capital means that the company has a lot of money tied up in the operating cycle, which can create cash flow problems and a negative impact on overall liquidity. The creditor can help reduce working capital by accelerating receivables collection and minimizing payment delays, while reducing the outstanding balance of receivables.
Define Clear Credit Policies
Good receivables management begins with the implementation of clear credit policies. These policies should define credit terms, credit limits, and collection procedures for each customer, specifically tailored to the needs of the businesses involved.
Implement a Receivables Management Tool
Receivables management tools can greatly facilitate this process. Many professional software solutions can help you track invoicing, set up automatic reminders for late payments, and even analyze customer payment behavior to identify trends and potential risks.
The Different Types of Trade Receivables
In the business world, there are a multitude of terms to describe the different stages of a receivable. A good understanding of these terms and their accounting definition can help to better manage the life cycle of a receivable. Here are some of the most commonly used terms.
Pending Receivable
A receivable is said to be "pending" when the corresponding invoice is not yet due, because the service or the delivery of the goods is not fully completed. This is an initial stage of the receivable's life cycle.
Certain Receivable
A receivable is considered "certain" when its existence is incontestably established by documents such as a signed quote, a purchase order, a validated delivery note, or correspondence by mail or email confirming the transaction.
Doubtful Receivable
A receivable is said to be "doubtful" when the customer business is experiencing financial difficulties, making the partial or total recovery of the invoice unlikely, thus increasing the volume of potential unpaid invoices. This does not necessarily mean that the receivable is uncollectible, and in general, VAT recovery is not authorized as long as it remains doubtful.
Disputed Receivable
A receivable is considered "disputed" if the customer contests the completion of the service or the delivery of the goods and consequently refuses to pay the invoice, often invoking legal arguments to support their position.
Due Receivable
A receivable becomes "due" when the payment deadline written on the invoice has been reached, thus calling for settlement. In general, a receivable is due upon receipt of the invoice, unless a credit period has been granted.
Liquid Receivable
A receivable is said to be "liquid" when all the elements necessary for its evaluation are present on the invoice, including the amount and the currency.
Old Receivable
An "old receivable" refers to a receivable whose payment date has passed and which has not been collected. After a certain period, generally two years, the receivable becomes time-barred and the company can no longer collect it through legal means.
What Are the Key Performance Indicators (KPIs) for Trade Receivables?
An essential element for optimizing trade receivables is to monitor key performance indicators. The most important KPIs are the average receivables collection time (Days Sales Outstanding or DSO) and the payment default rate.
DSO (Days Sales Outstanding)
DSO measures the average time required to collect a receivable once the sale has been made. A shorter DSO is generally preferable, as it means the company recovers its money more quickly.
The Payment Default Rate
The payment default rate is the percentage of invoices that remain unpaid after a certain period. A high default rate may indicate a problem in credit policies or in the sales and collection process.
Trade Receivables Collection
Before talking about collection, let's first discuss the concept of "reminder." The reminder is an important action to encourage the debtor to settle their debt. It can be done amicably, for example through a phone call or a reminder email, before moving on to more formal measures that involve an increased risk of damaging the customer relationship.
Even with the best receivables management strategy, it is inevitable that some invoices will remain unpaid. In these cases, a business must move on to the receivables collection stage. This is often a delicate process aimed at recovering the funds owed without damaging the customer relationship.
Collection generally begins with a series of friendly reminders, by mail or email, signaling the payment delay to the customer. If this does not work, the business can then move on to more formal measures, such as sending a formal demand letter.
If the customer still does not respond or refuses to pay, it may be necessary to call upon a collection agency or a lawyer. In some cases, it may be necessary to initiate legal proceedings to recover the debt. However, these measures should always be the last resort, as they can damage the customer relationship and lead to additional costs.
Best Practices for Receivables Collection
A good practice for receivables collection is to establish a clear and consistent strategy that begins from the first day of payment delay. This process can include automatic reminders, phone calls, and possibly formal demand letters.
It is also useful to establish open communication with customers. If a customer is experiencing financial difficulties, it may be possible to find an arrangement, such as a staggered payment plan, that benefits both the customer and the business.
It is important to document all communications and actions taken during the collection of a receivable. This documentation can be essential if the company has to initiate legal proceedings to recover the debt.
Finally, it is important to remember that the contract between the business and the customer should always include clear clauses regarding invoice payment, including the amount, the due date, and the consequences of payment delay. It may also be useful to include a clause allowing the company to recover legal fees in case of dispute. This can encourage customers to pay on time and help avoid collection costs.
Conclusion
Trade receivables are an essential aspect of a company's financial management. Effective receivables management can help maintain a healthy cash flow and minimize the risk of payment default. Moreover, an effective collection strategy can help recover unpaid funds while preserving customer relationships. It is therefore essential for any business to have a good understanding of these concepts and to implement effective systems for receivables management and collection.
You can choose simple and intuitive software to manage your trade receivables. Flowie is a solution specifically designed to address these challenges, including accelerating the collection of your money.
To discover how Flowie can help you simply manage your trade receivables, book a demo here.