CFOs and other financial executives need to constantly balance the cost of doing business with the risk of doing business.
Jonathan Theders, president and chief operating officer of Clark-Theders Insurance Agency, says managing your accounts receivable is a large part of managing that balance.
“In a typical business, you’ve got several assets on your balance sheet,” Theders says. “You’ve got plant and inventory. You’ve got cash in the bank. But typically 40 to 70 percent of a company’s assets are the receivables that it holds on its balance sheet. And with that comes a lot of risk.”
Smart Business spoke with Theders about how you can keep the money rolling in by protecting your accounts receivable.
Why should businesses be concerned about the vulnerability of their accounts receivable?
In today’s economic environment, you have some unbelievable businesses going bankrupt. You never would have thought Kmart, Circuit City, Dana Corp. or GM would be struggling to this extent.
You look at all of these companies and ask, ‘How can these giants go bankrupt?’ Think not only of GM. Think of the people who supply to GM, the people who are waiting for payment from GM for their radios or their brakes or whatever component part they create.
The moment that firm goes bankrupt and you’ve got these huge outstanding accounts receivable, you may never see any of that money. You may see a percentage of it, but if GM is unable to pay its obligation to you, that negatively impacts your cash flow, earnings and capital. It can even put you out of business.
What can an executive do to control the volatility and vulnerability of a company’s accounts receivable?
Financial executives need to weigh the benefit of several options on how to mitigate that trade credit risk how to control vulnerability of your accounts receivable.
There are several ways you can control it. You can self-insure it, which many people do. You can set up a bad debt fund, where you’re putting your dollars into this fund to help fund it. Or you can do what a lot of people do and just deal with it when it occurs.
Another option is factoring, where you send all of your accounts receivable to a third party. You have a third party billing it and, depending on the risk of the business, it may take 1 to 10 percent of that invoice as its fee for collecting the money. In that case, you’ve pushed the obligation off to another company for the collection, so you’ve controlled it to a degree, but at the same time, you’re cutting out 1 to 10 percent of your profit margin to do that.