by Gilbert C. Osnos
(TMA International Headquarters)
analysis of accounts receivable can provide a wealth of information and insight
about an organization, its effectiveness, its policies, and how customers view
the company. In turn, such an analysis can provide insight into areas in which a
company’s policies and procedures need to be
Receivable deductions are reflected on the income statements as returns,
allowances, and discounts. What may not be apparent — because they have not yet
been recognized — are unapplied credits. These items tend to distort the
receivables balance and reflect future cash collections that may never
materialize. Many income statements begin with net revenue. Simply displaying
net revenue can mask the dilution from gross revenue.
An organized and systematic review of returns, discounts, and allowances
indicate adjustments that reflect, in part, current policies and practices.
Hidden from view are unapplied credits to the receivables ledger. These
unapplied credits and the aging report have proven to be great places to hide
problems that can impact a company’s viability. Fortunately for many executives,
problems often are opportunities waiting to be
Receivable aging reports, unapplied credits, and
unapplied cash should be reviewed at least once a month. An in-depth review of these aging items can
indicate lax credit administration, quality problems, or a failure to adhere to
company policies. Unapplied credits distort the collectability of receivables,
while unapplied cash can impede the ability of the collection department to
pursue account debtors aggressively. It can prove embarrassing
to call for a
collection, only to learn that the invoice already has been paid but has not
been applied to the receivables ledger.
Reasons for customer deductions may include disputes over pricing,
failures to post correct prices on orders, unauthorized returns, unauthorized
discounts, unauthorized advertising allowances, a failure to adhere to
customers’ shipping instructions, late deliveries, partial shipments, and
quality problems. This treasure chest of information provides a great
opportunity to gain insight into organizational
To be useful, the data first must be organized into a meaningful report.
This can be accomplished by establishing a specific code for each type of
deduction for each classification — in other words, reasons for returns, reasons
for discounts, and so on. A periodic ranking by dollar amount and frequency
provides senior management with insight it needs to help prioritize problems and
attack them in the proper sequence. Systematically addressing problems in a
prioritized manner can provide the greatest impact to bottom-line performance
and free up working capital.
Getting to Root Causes
An investigation of slow
receivables indicated that one company had major problems in manufacturing.
Although its balance sheet looked healthy and its income statement did not
indicate any problems, the company was short of cash. A review of the aged
receivables suggested that difficulties existed. Further investigation revealed
that the company had been shipping defective goods in one product line to
customers who refused to pay until the problems were
corrected. To address the root causes of the problems, the company undertook a
comprehensive review of its manufacturing processes, along with its product
design and development.
Another company had acquired and rolled up several companies in a very
short period of time, and the new owners were in a rush to realize economies of
scale they were certain would follow. Management was inexperienced and reacted
to the pressure to produce cost savings without first adequately addressing how
to combine and eliminate redundant functions
One of the first things the company intended to do was to centralize all
receivable and collection management into one location. Each company had its own
receivables software programs, which were not compatible. Outstanding invoices
were packed in boxes and sent to the new centralized location.
At the corporate level all receivables were combined, but in many cases
there was no way to apply a collection to a specific account debtor’s invoice.
All new receivables were recorded on about six of the old systems, and
collections were monitored on them. There were stacks of old invoices — too many
to track each collection from each account
The amounts owed by each customer were known at the time of the
acquisition, but the ledgers were not maintained afterwards. It is difficult to
call a delinquent account if its ledger is not up to date. For those who did not
pay, the company had no backup information to prove that fact. The collections
department became gun-shy about making calls, because some customers no longer
were doing business with the company, and many others already had paid —
although received, these payments had not been applied. Even worse for the
company, when an account was past due and no longer included in the collateral
pool, the business’ borrowing capacity was
Receivables aging at the corporate level kept growing, and lenders,
management, and the board did not understand why. Addressing the problems
required launching a range of initiatives that included:
- Writing a new enterprise software program to consolidate the remaining
systems into one.
- Hiring an outside collections firm to see if it could work down the pile
of old receivables.
- Ensuring daily discipline in applying cash to the individual account
- Researching and booking authorized unapplied credits to each account
another company experienced difficulties several years ago, finding that many of
its customers had reached their credit limits and could not purchase any more
goods and services. Collections were slow, and the company sorely needed cash.
In response, the accounting department was organized into teams, each of which
was provided with a list of slow payers to contact during a
The results of the telephone blitz were impressive. Cash receipts were
accelerated, and disputes were reconciled. The telethon also uncovered a
disturbing fact — many accounts carried different company names but had the same
address and phone number.
In the past, the company’s credit department had allowed any new account
as much as $500 credit before performing an in-depth analysis to determine if
more credit was warranted. Taking advantage of the policy, the company learned
that sales representatives in one region had opened new accounts for customers
under different names once those clients had reached their credit limits and
could not buy any more.
Because the reps were paid commissions based on sales and not on
collections, they simply opened new accounts under different names for customers
whose accounts hit their credit limits. By doing so, customers received
additional goods and services, invoices for which often went unpaid, and sales
representatives continued to receive commissions. In effect, the sales force was
stealing from the company.
Not only was the district manager aware of the practice, but he also
condoned it. Because he also was evaluated and rewarded on gross revenue
generated and not on collections, the manager had an incentive to maximize sales
figures, regardless of whether the company collected money it was
Without a thorough aging review and the resulting telethon, the company’s
management might not have discovered the irregularities. The day after the
problems were identified, the company made some major personnel changes and
instituted modifications to its credit and collection management and policies.
Now, there is no profit until cash is
periodic review of the ranking of deductions, aging, and unapplied cash and
credits enables top management, an audit committee, and the board to ask the
right questions. The insights gained from these reviews maintain management
focus on receivables investment at the proper level and improve organizational