What is the single most important thing your business does?
There are many possible answers: building relationships, providing value, taking care of your people and solving problems for others. One thing all organizations have in common, however, is the need for cash. How you manage your accounts payable and accounts receivable functions makes all the difference.
There are a few key things every business should know about these two critical functions.
Why Accounts Receivable Are So Important
Let’s start with accounts receivable. If your customers pay on time, every time, without reminders, that’s great… you can skip ahead to the end. Still here? I thought so. Managing accounts receivable takes far more effort than most realize.
First, you need a clear strategy for the payment terms you offer. For many customers, terms are just as important as price, so you need to understand what your competitors are offering. When possible, match or slightly improve on those terms, but not too much.
Offer only what’s necessary to stay competitive. Don’t give away more than you can afford. And if you are paying your own bills in 30 days, you should not be offering terms longer than 30 days unless you know exactly where the cash will come from.
When determining how much credit to extend and for how long, you need to know how to evaluate your customers. Obtain their financial statements, especially the balance sheet. Audited or reviewed statements are ideal, but use what you can get.
Focus on current assets – cash, accounts receivable, inventory and other short-term assets – and current liabilities, such as accounts payable, upcoming tax liabilities, unpaid payroll and similar obligations. Be sure to include any operating loans secured by current assets.
With this information, calculate the current ratio by dividing current assets by current liabilities. The ratio should be greater than one. If it’s less, it’s a sign the customer may struggle to pay current bills on time, and you should proceed with caution.
I also strongly recommend using a paid credit service such as Dun & Bradstreet or Experian. These tools may not tell you exactly how much credit to extend, but they are effective at identifying customers who pay slowly, have judgments, or may be nearing failure.
Once you’ve set credit limits, the next step is collecting the money. This responsibility should be handled by someone you trust. Collections, like sales, are a key point of contact with your customers and require effective, consistent communication.
Issue regular statements so everyone stays aligned and to avoid uncomfortable conversations about balances and timing. As a rule of thumb, if more than 20% of a customer’s balance is past due, especially if it’s over 30 days, it’s likely time for open, candid discussions.
Wherever possible, automate receivables processes so your team can focus on relationship management rather than clerical work.
When it comes to collections calls, tone matters. The person making these calls should have a friendly demeanor and rely on clear, respectful communication rather than stern demands. Listen carefully to your customers. If there’s an invoice dispute, involve your sales and operations teams to resolve it instead of simply pushing for payment. Remember, you likely want to continue doing business with these customers.
The Basics of Accounts Payable
Next, turn your attention to accounts payable. There are many myths about when and how to pay bills, and most are incorrect. Your goal is to pay vendors in a way that preserves strong relationships while managing cash effectively. As a CFO managing a large receivables portfolio, I can say I’m far more comfortable extending more credit and longer terms to companies that consistently pay on time and without reminders.
Some companies try to stretch vendors by a few days to conserve cash, but the damage to vendor relationships is rarely worth it and can limit your ability to secure credit later. If those extra days are critical to survival, there are likely deeper issues that need attention.
As with accounts receivable, make sure your vendors provide regular statements. If they don’t, ask for them. Staying in sync with vendors is just as important as staying aligned with customers. Knowing where you stand helps you plan payments and manage cash flow.
Once you fall out of alignment with a vendor, it can take significant time and effort to resolve. Automating accounts payable processes can free your team to focus on maintaining strong vendor relationships rather than handling administrative tasks.
Finally, ensure the timing of accounts receivable and accounts payable aligns. If customers pay in an average of 30 days, you should aim to pay vendors on a similar schedule. If that’s not possible, your business must have sufficient excess cash, or access to it, to cover the gap. For example, if customers pay in 90 days but vendors require payment in 30 days, you must fund a 60-day cash gap.
In practical terms, if your monthly cash outflows are $100,000 (roughly 30 days of expenses), you’ll need at least $200,000 in excess cash to operate; more if the business is growing. Ideally, vendor payment terms are longer than customer payment terms. In that scenario, the business can fund itself and grow without requiring additional cash contributions.
Keep a close eye on these two essential functions: accounts payable and accounts receivable. Each represents a critical interaction point with customers and vendors that should not be overlooked. Managed well, they help reduce risk, identify issues early, maximize cash flow and minimize the personal financial drain your business places on you.
Allen Riggs is the chief financial officer at PSA Network.
