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Small Business Can Use Bad Debts to Generate Working Capital

By University Alliance
Small Business Can Use Bad Debts to Generate Working Capital

It’s tough to say what percentage of revenue the average small business carries in outstanding receivables and bad debts. But it’s clear that throughout the recession, countless business owners faced greater difficulties collecting outstanding invoices. And for many, it meant the difference between surviving another year and closing their doors for good.

All smart business plans account for downturns and cash flow fluctuations. But there is nothing more important than managing cash flow to ensure your business can pay vendors and employees, and sustain itself through tough times. When a small business carries excessive accounts receivable, the bottom line can suffer immensely.

And when a sale turns into a bad debt, your investment of time and money becomes a loss. Every customer sale has associated costs: start-up expenses, costs related to marketing efforts, sales expenses, inventory, production, labor and more. Collecting bad debts allows you to recover some of your investment – and is simply sound business administration.

Fortunately, there are alternatives for business owners who face a high level of accounts receivable and bad debts, including accounts receivable financers and collection agencies.

Accounts Receivable Financers

Business owners can enjoy a stronger cash flow and greater financial leverage by working with accounts receivable financers, also known as “factors.” Factoring firms purchase a business’s accounts receivable at a discount, in exchange for cash that the business owner can immediately put to use for expenses or operations. The factor typically pays about 70 – 85% of the value of the debt, and then assumes the risk of collecting the receivables. The balance of the value of the accounts receivable is paid to the seller upon collection, minus the factor’s commission and other fees.

If your cash flow is generally healthy, but you have long-running outstanding invoices, you may decide to write them off. But there is another option that can strengthen your bottom line: collection agencies.

Call in the Collections Experts

Many small businesses have outstanding accounts receivable in the 90 – 120 day range. Rather than giving up on these invoices and writing them off as bad debt, why not consider having a collection agency take care of it? Recovery rates vary, but any percentage of repayment can help keep your cash flow positive. Collections agencies charge a percentage of what they collect, which may vary from 18 – 33% or higher, depending on the amount collected. Here are some tips to keep in mind when deciding whether to send an account to collections:

  • Don’t turn over an account for collection until you are sure you can’t collect it. If you have the time to put in the effort, you’ll save money by collecting it yourself.
  • Many collections agencies have a minimum invoice amount, but may consider multiple smaller invoices.
  • Use caution when deciding which accounts to send to collections. Some are not saleable, and others may not be worth any subsequent harm to a business or personal relationship.
  • Gather pricing information from several collections firms. Choose one that charges fees only when they collect. Ask for and check references. Find out how successful the firm is, and whether they are courteous and professional. Remember, the manner in which your accounts are collected reflects on your business.

Selling your business’s accounts receivable can be very effective in quickly strengthening cash flow and improving revenue. Rather than writing them off as a bad debt, you realize a gain that goes straight to the bottom line.

In addition to accounts receivables, a business’s debts also affect the cash flow equation. If you’re experiencing a crunch, you may not be able to pay every vendor invoice by the due date. That’s when it’s time to try renegotiation.

Renegotiate To Buy Yourself Time and Improve the Bottom Line

If you need to pay your suppliers and protect your cash flow, talk to your vendors before borrowing money to pay invoices. Many of your long-time vendors and suppliers will be flexible in the short term, especially if you are a good customer with a strong payment history. Here’s how to approach this negotiation:

  • Prepare: Make sure you’re ready to make a strong case. Gather data, such as your average revenue stream and billing cycles. For example, if you generally see an uptick in business in March, your vendors may grant extensions on February invoices – if you have the data to back up what you tell them.
  • Keep communications flowing: Be honest. If you’re having cash flow problems, call suppliers and ask for extended terms. Don’t let stress or anxiety keep you from having necessary conversations. They’ll appreciate it and be more open to working with you.
  • Determine which vendors are more important to pay: If your personal assets are tied to any of your business purchases, those vendors should be at the top of the list.

If you’re a good customer, who treats your vendors like the important business partners they are, you may be surprised at how understanding and flexible they can be.

Use Outstanding Receivables to Keep Cash Flowing

The business environment is tough, but better times are surely ahead – if you can keep your cash flow healthy and your business sustainable. So take a look at your outstanding accounts receivable and bad debts. Leveraging these accounts for instant cash may be one of the best business decisions you make, and really pay off in the long run.

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Category: Business Administration