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Incoming Financial Control Systems Design

Financial Control Systems can be divided into two main categories, “Incoming” Systems and “Outgoing” Systems. As their names suggest, Incoming Systems control the flow of money into your business, while Outgoing Systems control the flow of money out of your business.

Incoming Systems manage the flow of money into your business from all external sources. These will typically be money from cash and/or credit sales, but could also include money from lenders, investors, or even you, the owner.

While you may wish to donate time and/or money to any number of worthy causes, your business must still make a profit or it won't survive. In order to make a profit, your business needs to be paid. It's a simple and rather obvious point yet many business owners spend precious little time or energy making sure it happens. The result is that customers are invoiced late, overdue invoices are ignored, and more bad debts are written off than necessary.

For example, you should have a system in place for invoicing your customers accurately and promptly. When you are slow or lackadaisical with your billing, you give your customers an excuse to behave the same way with their payment.

The same goes for overdue accounts. Many business owners let this slide much further than they should because they see collections as an unpleasant task. But it's vital that you stay on top of your receivables. The longer you wait, the less likely you will be to collect your money and/or salvage the relationship with your customer.

In most cases it's important to maintain a positive relationship with your customers. Most people really do want to pay their debts and may be embarrassed that they have fallen behind, so treat the situation delicately. If this is a one-time situation, you'll want their business again.

The five basic categories of Incoming Financial Control Systems are:

  1. Sales Receipts Systems
  2. Cash Receipts Systems
  3. Invoicing and Accounts Receivable Systems
  4. Credit Management Systems
  5. Collections Systems

Sales Receipts System

The first financial system to kick into action when a sale occurs is your Sales Receipts System. It records the sale in real time and is therefore the most important part of the transaction. A basic Sales Receipts System should record:

  1. The products/services sold
  2. The type of sale (cash or credit)
  3. The date of the sale
  4. The amount paid for every sale

…but your systems can go much further than this if you like. For example, this can also be a good time to collect:

  • The customer's name and contact information
  • Other useful customer information such as their purchase preferences
  • The sales person's name
  • The time of the sale
  • Other pertinent information

To ensure accuracy and to safeguard your business from fraud, automate this process as much as possible. A retail business, for example, could use a computerized point-of-sale system to track the details of each sale in real time.

Cash Receipts System

Because cash is less traceable than cheques or credit cards, it's often a good idea to record its inflow separately. How is the receipt of cash handled in your business and what safeguards are in place to ensure its accuracy? Good Cash Receipts Systems can help protect honest employees from false suspicion, but they can help identify fraud when it occurs as well.

Your Cash Receipts System will likely be a sub-system of your Sales Receipts System. From an analysis perspective, cash is treated in a unique manner. Keep in mind the following when designing it.

  1. Cash handling and recording should be kept separate by dividing the tasks between two different people (unless it's done by you).
  2. All cash received should be deposited daily and a receipt from the bank should be kept on file.
  3. Cash received should be reconciled daily with sales receipts.
  4. Cash should be recorded the moment it is received.
  5. Cash should immediately be stored in a secure location (i.e. a cash box or cash register). Once this cash exceeds a predetermined amount, it should be moved to a more secure location (i.e. a safe or a bank).

Invoicing and AR System

How are your credit sales handled? Despite their obvious importance, a surprising number of business owners do not send out detailed invoices in a timely manner. It's the only way to ensure a consistent inflow of cash. It is imperative invoices are sent out promptly, they are clear and accurate, and all accounts are monitored to ensure payments are received.

What are the terms of payment you offer your customers? Are these terms clearly identified on your invoices?

When do your invoices go out, how are they delivered to your customers, and who is accountable for this?

When the money comes in, who confirms the accuracy of the payments and how does this occur?

Accounts Receivable Aging Report

This report will keep you up-to-date concerning the status of your receivables. It easily shows you at a glance how much money you have in receivables at any given time. It also shows you how many customers are overdue with their payments and by how much. Most accounting software will offer Accounts Receivable aging reports along with many others.

CustomerCurrent31-60 Days61-90 DaysOver 90 DaysTotal
ABC Inc.5,0001,0000.000.006,000
Acme Ltd.,0002,000
Big Corp.2,0000.000.000.002,000
XYZ Co.0.004,0000.000.004,000
Small Co.3,0000.000.000.003,000
Ace Ltd.0.000.003,0000.003,000
Smith and Co.1,0001,0000.000.002,000

Credit Management System

Your best defense against bad debt and slow payers is a well-organized Credit Management System. If you are in a position to avoid offering credit altogether, you have a fortunate advantage. However, in many industries, especially business-to-business industries, this is not possible.

A good Credit Management System will:

  1. Help you identify higher credit risk customers, keeping you from extending them too much credit (or any credit at all).
  2. Provide a set of guidelines for assigning credit to new customers.
  3. Define your credit terms.

How do you currently determine the amount and terms of the credit you extend to your customers? Do you perform any type of credit check?

How long do customers have to pay back their debt?

Do you offer a discount for early payments? If so, how much? A two percent discount for payment within 10 days is common.

Do you charge a penalty for late payments? If so, how much?

Determine the amount of credit to extend to new customers based on the results of their application and remember to always check credit references. For existing customers, your Accounts Receivable Aging Report will give you a clear picture of their credit worthiness.

Answer the following questions, and then design your Credit Management System below.

Document your thoughts on your own system in the space below.

How long will you give your customers to pay their bills?

How will you decide to increase, decrease, or eliminate their credit limits?

On occasion, you will encounter businesses or individuals who apply to you for credit, who, for one reason or another are not a good candidate to extend credit to. When you encounter a credit risk that you have determined is too great, it's important to handle credit denial in a professional and formal manner.

Collections System

What happens when customers are late with their payment? Do you have a standardized approach for handling this situation?

Despite your diligence when granting credit, customers will occasionally be late with their payments. But before jumping to conclusions, make sure you find out exactly why their payments are late. It could be an honest mistake on their part, or perhaps they are going through a temporary financial slump. This kind of information will help you to choose the right path to take in order to get your money without losing your customer.

Some possible reasons for late payments are:

  • They do not understand the terms.
  • They are unhappy with your products or services.
  • They are experiencing financial difficulties.
  • Their accounting department is disorganized.
  • They have questions about the invoice.
  • They did not receive the invoice.
  • The invoice went to the wrong person.
  • They are unethical and don’t want to pay the bill.

As you can see, there are many possible reasons why an invoice might go unpaid. If a customer is behaving unethically or dishonestly you may need to take aggressive action, but in the majority of cases you will find immediate and honest dialogue to be your best solution.

Often, a business owner will avoid dealing with unpaid receivables because of the possibilities for conflict. Unfortunately, the longer they are ignored, the harder they are to collect. Dealing with overdue receivables in a timely manner not only increases your chances of being paid, it strengthens your business relationship with your customer. Remember, in all likelihood, your customer knows that they're overdue and may feel awkward about it as well.

The cost of uncollected receivables is higher than many business owners realize. First of all, receivables cost you money every day they remain unpaid. If, for example, at any given time you have an average of $100,000 in uncollected receivables, assuming a 5 percent interest rate, they are costing you $5,000 a year. The longer you wait for your money, the more it will cost you. It's like being in the business of loaning money out for free.

Then there is the problem of “bad debt.” Even small losses here can have a big impact because not only have you lost your potential profit, you have lost your expenses as well, all of which must be made up in future profits. If you write off a $100 item with a profit margin of 10 percent, for example, it will take you 10 more sales to make up for the lost revenues. That means you will need $1,000 in extra sales just to break even!

Your best opportunity to support the inflow of cash into your business is a collections system. Depending on your business, it may be nearly impossible to completely eliminate “bad debt” and late payments, but you can certainly make improvements. For many business owners, the peace of mind a good collections system can bring is worth almost as much as the money they save.

Following are some points to consider when developing your collections system.

  1. Decide at what point your collections system will take over from your accounts receivable system. For example, if your receivables are due in 30 days, your collections system might take over on day 45 for most accounts and on day 31 if payments have been late more than twice.

  2. Assign one person to the overdue account. One of the keys to collecting debts is the establishment of a trusting relationship. If several people get involved, the process will lose its personal touch. People are more motivated to pay back an individual than a faceless company or collections department.

  3. Design a standard response for overdue accounts. A letter is often best in the initial stages of delinquency, but however you handle it, plan your approach in advance. The key here is consistency. The longer you wait, the less likely you will be to collect, so don't put it off.

  4. At some point, a telephone call becomes necessary. When you call to collect on an overdue account, make sure you are talking to someone with the authority to spend money. Promises of payment from the wrong person will only cause frustration.

  5. Always record the person you are speaking with, the time and day of the call, and any other pertinent information. You'll need this information to be accurate should you make a follow up call.

  6. Get a commitment to make the payment by a specific date. Get this in writing if possible. If you can't, document the new agreement yourself and send them a copy for their files.

  7. If your customer is unable to pay in full, put them on a payment plan. Also, get an initial payment, no matter how small. This represents their commitment to bringing the account up to date. Also, if worse comes to worse and you must write off the loss, some money is better than no money. Of course, this will vary by industry. There are some industries where payment plans are unrealistic, and would not be considered common place.

  8. Remind them of the original agreement. Be polite yet firm. Your goal is to have them live up to their agreement without getting their back up. It's tough to do. People don't like to admit that they are wrong, so give them the opportunity to maintain their dignity by offering a “way out.” For example, you might ask if there was anything unclear about your invoice.

  9. Express your appreciation for their payment. It should be your goal to keep this client if possible. You never know what the future holds, so it's best to avoid burning your bridges unless absolutely necessary.

  10. A lawyer's letter can be effective. Or, if necessary, you may apply for a lean against assets.

  11. If all else fails, pass the account on to a collections agency. Some are better than others, so ask other business owners whom they use. If you need to go this far you will want to use the best agency possible. You may want to “factor” or sell your accounts receivable to a specialized collections agency. You will do this at a loss, but it may still be better to cut your losses and get something back.

  12. If the collection agency fails, and if there is sufficient money involved, you may decide to take legal action, but keep this as a last resort. It can be costly and time consuming, so if the invoice is small, you may prefer to write it off as a “bad debt.” Your lawyer can advise you on this.

Answer the following questions, and then design your Collections System below.

What is your maximum time period for your “accounts receivable?”

  • Payment up front
  • Cash on Delivery
  • 15 days
  • 30 days
  • 60 days
  • 90 days
  • Other ___

Do you have any other terms (i.e. 10 percent down payment required)?

What is the average time it takes for your customers to settle their accounts (your average collection period)? How does this compare with the terms you offer your customers? Is this acceptable? How much “bad debt” do you write off each year?

What is this costing you in lost revenues (Bad Debt + Profit Margin)?

How efficient is your existing collections process?

Create your Collections System. Organize any other Incoming Financial Control subsystems not addressed yet for your business.