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Converting accounts receivable into cash is a critical process in the development of a healthy cash flow. While booking a receivable is accomplished by a simple accounting transaction, the process of maintaining and collecting payments from your customers requires a steadfast commitment to a systematic process of Accounts Receivable Management. To more effectively convert accounts receivable into cash it’s essential that the credit and collection process be highly efficient in order for you to shorten the accounts receivable cycle time.

The accounts receivable cycle starts with a sale (credit sales) which in turn creates a receivable (monies due your company), and then, ultimately converts into cash. The length of time that it takes your company to complete this cycle, from sale to accounts receivable to cash, is the collection period. The shorter the collection period, the less time cash (capital) is tied up in the business process, and thus the better for your company’s cash flow.

Try to limit outstanding accounts receivable to no more than 10 to 15 days beyond your credit terms. If your credit terms are net 30 days, then the collection period should not extend beyond 45 days. Keep in mind that average collection periods do vary because of industry standards, company policies, or financial conditions of the customer. Comparing your company’s actual days of collection to the average days of collection within your industry is a wise business practice. Benchmarking your actual days of collection to that of your target days of collection (no more than 10-15 days over credit terms) is also advisable.

Your company’s average collection period is calculated by using an Average Collection Period Ratio. The ratio is referred to as an Activity Ratio; it measures how quickly your company converts non-cash assets to cash assets.

Average Collection Period (ACP): ACP = Accounts Receivable / (Credit Sales/365))

A high Average Collection Period implies that your company may be too liberal in extending credit to your customers and too lax in the collection process. A low number of days in your collection period could imply that your credit and collection policies are too restrictive. This restrictive position may be repressing your sales.

Accounts Receivable Turnover Ratio (ART) is an accounting measure used to quantify your company’s effectiveness in extending credit, as well as, collecting its debts. This ART Ratio is considered a Liquidity Ratio; it measures the availability of cash to pay debt.

Accounts Receivable Turnover (ART): ART = Net Credit Sales / Average Accounts Receivable

A high Accounts Receivable Turnover Ratio implies that, either your company operates on a cash basis, or that its extension of credit and collection of accounts receivable is efficient. A low ART Ratio implies that your company should re-assess its credit policies in order to ensure the timely collection of monies due from the accounts receivable ledger.

A key requirement for effective Sales and Accounts Receivables management is the ability to intelligently and efficiently manage your entire credit and collection process. Greater insight into a customer’s financial strength, credit history, and trends in payment patterns is paramount in reducing your exposure to bad debt. While a comprehensive collection process greatly improves your cash flow, your ability to penetrate new markets and to develop a broader customer base hinges on the ability to quickly and easily make well informed credit decisions and, to set appropriate lines of credit. Your ability to quickly convert your accounts receivable into cash is possible if you execute well- defined collection strategies.

Credit Process:

The initial requirement of an effective credit management process is to have each company that you plan to do business with, complete and sign an Application for Credit form. Your Application for Credit form should include, the “terms and conditions of sale,” space for the prospective customer to provide information on company background, a list of principal owners with their percent of ownership, three to five trade credit references, and the name of their bank(s).

It is important to personally review with the prospective customer their projected product purchases – in both dollars and in units. This review helps to initially assess the amount of credit necessary to purchase the projected products. This review also helps to determine inventory requirements based on a projected sales forecast

Collection Process:

An efficient and effective collection management process includes well defined policies and procedures that facilitate a more expedient, sale–to-cash cycle. The collection procedures require “attention to detail” and should include:

• Billing: Preparation, recording, and delivery of invoices as soon as the product/service is delivered or installed.

• Statements: Preparation, recording, and delivery of follow-up statements that indicate aging of outstanding balances.

• Accounts Receivable Aging Schedule: Preparation and distribution of an Aging Schedule that lists all of the customer accounts that have outstanding balances. These outstanding balances are then categorized into 4 categories of time: 1 to 30 days, 30 to 60 days, 60 to 90 days, and over 90 days.

• Telephone Calls: Placement of courteous and professional telephone follow-up calls to customers with past due, outstanding balances for the purpose of establishing a date of payment.

• Collection Letters: Preparation, recording, and delivery of collection letters with an urgent message that demands payment and provides details of the action that will be taken if payment is not received by a certain date.

• Recording Payments: Posting of the amount of payment to the appropriate customer account. If possible, it is advisable that the person performing the collection duties not be involved with the posting of payments.

• Deposits of Collected Funds: Preparation of the deposit ticket, along with accompanying funds, should be deposited in the bank on a timely basis.

Factoring as an Option

Very simply, factoring is short-term financing that is obtained by selling or transferring your Accounts Receivable to a third party – at a discount – in exchange for immediate cash. In most cases, the third party, a factoring company, audits your accounts receivable to determine their collect-ability. If the factoring company feels that your receivables are bona fide then, they will offer to purchase the current ones at a discount. A factoring company may also, under the right circumstances, purchase your future receivables at discount off the face value of the receivables. The percentage discount depends upon the age of the receivables, how complex the collection process will be, and how collectible they are.

Once the factoring company collects a particular receivable, they will pay you the remaining balance of that receivable’s face value, less their fee. Fees vary widely from one factoring company to another. So, it is recommended that you do your due diligence before engaging the services of any particular company. Factoring fees are not insignificant when compared to the amount of interest you might pay to a commercial lender. For this reason alone, you should view factoring only as a short-term solution rather than a regular outlet for collecting your receivables.

Many businesses, that need an immediate infusion of cash in order to survive and/or to bridge their cash flow gap, could benefit from the process of factoring accounts receivable. Since failing businesses regularly turn to factoring as a last resort, factoring may be viewed by many people as a negative. Although factoring may be a great way to generate cash quickly, you should consider the perception that factoring may convey to your customers and to others in your industry. Your good judgment here should dictate if your company could benefit from the quick cash flow that factoring provides, or whether or not it would be just adding to your company’s financial burdens.

Shortening the accounts receivable cycle time generates the healthy cash flow that is required to sustain your company’s growth and prosperity.

Copyright 2008 Terry H. Hill:

Terry H. Hill is the founder and managing partner of Legacy Associates, Inc, a business consulting and advisory services firm. A veteran chief executive, Terry works directly with business owners of privately held companies on the issues and challenges that they face in each stage of their business life cycle. To find out how he can help you take your business to the next level, visit his site at http://www.legacyai.com

To download a copy of this article, click on this link:. http://www.legacyai.com/Article_Convert_A_R.html

Most contractors I run across confess “I never have as much money at the end of the year as I expect to.” Do you suffer the same fate?

Do you arrive at year end wondering where your money went to? If so, I’d bet you’d like to learn how to avoid that ugly outcome.

Pay attention here, I’m going to let you in on a little secret that will help you end those unpleasant year-end surprises. Lean in close. Don’t tell anyone about this. It’s so secretive that few contractors do it. Are you ready?

Use a budget

That’s it. That’s all it takes. Create a budget, track the variances, and take corrective action when necessary. Class dismissed.

Oh, you want to hear more? Okay. Keep reading to learn how to put a stop to those nasty year-end surprises.

Annual budgets allow you to stay on top of your financial progress as your year unfolds. They arm you with the ability to reel in expenses before they kill your bottom line. They force you to think through your business’ strategy and its resource allocations.

When you don’t have a budget to monitor, or don’t monitor the one you have, you are destined to arrive at year-end thinking “Rats. Where’d my money go?”

Contractors’ aversion to budgeting has always struck me as funny (not in the ha-ha sense). On the one hand, contractors tend to be obsessive about planning field work. They know that letting their field crews sort out what to do from day to day is a recipe for disaster. But on the other hand, they don’t apply that reasoning to their business. Lack of business planning leads to poor financial performance; it’s as simple as that.

You need a budget, it needs to reflect the reality of your market, you need to keep a close eye on its progress, and you need to take corrective action when it’s called for. Anything short of this will leave you with that “What happened?” feeling.

Look at the Market

Before diving into the how-to budget details, let’s make sure you understand the connections between your budget, your business plan, and your market.

Your budget is a financial representation of your business plan. Your business plan’s purpose is to take advantage of profitable opportunities in the market. Budgeting should not be attempted until your business plan has been developed.

Your business plan should be aligned to the size of your market, the prices your market will pay, and the cost of serving its needs. You can only make as much money as your market will support and your business plan will deliver. Budget accordingly.

Contractors often put the cart before the horse. They set sales, overhead, and net income goals, put them into a budget, and then try to craft a strategy to fulfill them. That sequence totally ignores the market.

It’s foolhardy to create the financial model and then try to craft a business plan that fits it when the business plan hasn’t been tuned to the market. First strategy; then budget; then meet the budget; then build a bulging bank account.

Your budget will be developed through five stages: preparation, rough draft, refinement, reality check, and rollout.

Stage 1 – Preparation

Unless you implement a new sales and marketing plan, you improve labor productivity, or you reduce overhead, your financial performance will be controlled by the market and the economy. If they grow, you will make more money. If they shrink, you will make less, or even lose, money.

In this industry, past performance is the best predictor of future performance – unless you force change. Build your budget on the foundation of your recent three year financial performance. To do that, gather together the balance sheets, income statements, and cash flow statements for those years.

Next, tap as many information sources as possible to gain an informed view of upcoming market changes. Visit with your banker. Visit with your insurance and bond agent. Buy construction forecast data from McGraw-Hill or a similar provider. Search the census bureaus’ website for reports on economic projections. Call the Federal Reserve and see what reports they have available. Call your local economic development councils.

Eventually, you will discover the experts’ consensus opinion. Even they can be completely blindsided by turns in the economy, but they are the most informed group to listen to.

Go over the information with your executive team. Reach consensus on your upcoming market opportunities.

Here are the Stage 1 steps.

Grab the last three sets of annual statements.

Gather up construction forecasts.

Discuss market opportunities.

Stage 2 – Rough draft

The purpose of the rough draft is to give you a reasonable starting point. Your rough draft will not consider changes to your business plan nor changes in the economy. To create the rough draft, study the income statements from the last three years and determine:

Your sales trends

Your direct cost trends

Your administrative overhead trends

Your sales and marketing expense trends

Your operations support trends

Your labor burden trends

Your average gross margin

Take your most recent income statement and adjust each line item for the trend (up or down) or jot down the three year average, whichever you feel is most appropriate.

Here are the Stage 2 steps.

Determine trends and averages for each income statement line item.

Decide whether the average or the trend is the most appropriate assumption.v

Mark-up last year’s income statement accordingly.

Stage 3 – Refinement

Now, adjust the numbers for changes in the market and changes in your business plan.

If you expect the market to shrink, assume both your sales volume and your margins will shrink. If you expect your market to grow, assume either your sales volume or your margin will grow. Do not assume both will grow (we’re not going to go into this but it usually holds true).

Now estimate the cost impact of new business strategies. For example, you may decide to expand sales by pursuing the office building market. In order to land the work, you will authorize a $10,000.00 advertising campaign consisting of magazine advertisements, direct mail, and client entertainment. This spending would be on top of the advertising you do to generate your current work load. Your advertising budget needs to reflect the additional $10,000 investment.

When thinking through your business plan, look at closely the cost impacts of:

Increased advertising to pursue new market

Expansion of sales staff

Purchase of new equipment

Adding office staff

Implementing or altering management information system

Employee training and development

Changing the bonus plan

Entering a new geographic territory complete with local office

Pay raises

Rising health care premiums

Another budget impact you need to account for is improved selling performance. Assume your sales team persuaded another 20% of your clients to hand you negotiated contracts. You budget would need to reflect the higher mark-ups associated with negotiated contracts.

You are ready to finalize your first draft. Adjust the trended or average numbers for each line item by the impacts of your business plan. Re-type the document so that it is easy to ready.

Here are the Stage 3 steps.

Verify your labor pool and operations support staff team can handle the projected work load.

Verify the targets for sales volume and direct cost markup are reasonable

Verify increases in marketing and sales expenses.

Update equipment expense and depreciation to accommodate new equipment needs.

Update sales volume goal.

Update direct cost margin goal.

Calculate expected work load (labor, material, equipment costs).

Revise and re-type your budget.

Stage 4 – Reality Check

One of the primary reasons contractors fail to hit their profit goals is because they are overly optimistic about their gross margins. The time has arrived for everyone to join a no-holds-barred discussion on operations and sales.

You need to challenge all assumptions made that the crews will perform better than they have in the past. No baseless, pie-in-the-sky claims are allowed. Unless, there is a reason to believe turnover has been greatly reduced, more efficient equipment has been purchased, or the operations management team will be able reduce downtime and rework, do not assume your labor will be more productive than in the past.

The other claim that you must question strongly is the ability of the sales and marketing team to generate better quality leads and better paying jobs. Sales and marketing personnel are highly optimistic individuals by nature. Take their promises of greater glory with a grain of salt. Believe it when you see it, not before.

In other words, don’t take their word on gross margins at face value. You need to analyze it segment by segment. Discuss the real mark-ups each segments produces. Pull out your job costing reports to see what the real mark-ups ended up being.

Ask them why they believe the leads will be better and why the margins will improve. Segment by segment, forecast total sales and margins. Pull them together and compare to your budgeted direct cost and gross profit.

Adjust your budget accordingly. Now, you’ve finalized your budget. Time to roll it out.

Here are your Stage 4 steps.

Call a meeting with your top operations and sales personnel.

Review and discuss field performance and projections for improvement.

Review and discuss advertising and selling segment by segment.

Tweak the budget based on the outcomes of these conversations.

Now, you’ve finalized your budget. Time to roll it out.

Stage 5 –Roll-out

Now that you’ve finalized the 12 month budget, you need to break it into manageable chunks (12 chunks that is). Create a spreadsheet with 14 columns. Label them by month. Each row is an income statement expense. The first column is the name of the expense. the second column is the total for the year. The third column is for January, the fourth for February, and so on.

Look at each income statement line item and determine whether it is an expense that stays consistent each month (e.g. office rent) or varies monthly. Many overhead expenses are billed twice a year or quarterly. Put the appropriate value under each month. The total for the months must equal the total for the year.

Pull up monthly sales for the last three years. Calculate the weighting of the sales per month. For example, if you typically sell $400,000 in July out of $3,200,000 annually, July accounts for 12.5% of your sales. Calculate 12.5% of your budgeted sales and direct expenses and put them in July’s column.

Continue filling out your spreadsheet until you have the entire budget accounted.

Make copies of the detailed monthly budget and distribute to all individuals who have spending authority. Pull them into a meeting, shut off the cell phones, and explain the detailed budget to them. They need to understand the expenditures planned by the budget, the logic behind the expenditures, the assumed gross margins, and the planned timing of the expenditures.

A word is in order here regarding cash accounting versus accrual accounting. If you are running your business on the cash accounting basis, you should set up your budget and track your progress on the accrual method. Cash accounting is great for taxes but terribly misleading for managing a business.

Here are the Stage 5 Steps

Allocate the annual expenses to the appropriate months.

Determine the historic pattern of your monthly sales.

Create monthly budgets for sales, field costs, overhead, and profit.

Present the detailed budget to your management team.

By completing the 22 step budgeting procedure, you now have in hand the tool that empowers you to manage your year end performance. Of course, the key word in there is “manage.”

Tracking

The second reason contractors fail to hit their year end financial targets is because they fail to track their progress against budget and take corrective action as necessary. Have your accounting staff generate an income statement and cash flow statement at the end of each month.

A word is also in order regarding your accounting staff. Whether inside or outsourced, your accounting staff must get you these reports no later than the seventh of the month. Hold them accountable to that date. They will probably whine like mad but ignore it. Timely reporting must be a non-negotiable duty of their position or service.

The monthly income statement should show:

Budget value for the month

Actual value for the month

Budget value year-to-date

Actual value year-to-date

Actual vs. budget variance for month

Actual vs. budget variance year-to-date

Projected year end based on current trend.

Gather together your management team, review and discuss the income and cash statements.

Taking Action

Budgets do not produce the results. Managing to them is what produces the results.

As variances become apparent, investigate their cause and take all necessary action. That may mean visiting with someone or some group who is underperforming and discussing things can be done to meet the performance goals. Taking action may mean revising the budget in accordance with changes in the economy and market.

When spending exceeds plan, or sales fall short, discuss the situation with your management team and decide how to get back on plan, and whether the spending needs to be scaled back to offset poor sales or increased to take advantage of unexpected opportunities.

You should not ignore unforeseen opportunities just because money wasn’t set aside for them. Adjust the budget as better-than-expected opportunities arise. Reallocate your resources or increase your budget to accommodate the needed investment.

Cash Budget

Translating your monthly income budget into a monthly cash budget is surprisingly easy and highly beneficial. Copy your income statement spreadsheet and translate the monthly sales figures into monthly cash receipts.

The way to do this is to look at your aged receivables. If you typically receive your money 45 days after the job, then your inbound cash trails your sales by one and a half months.

Your outbound cash is also pretty easy to figure. You field labor gets paid weekly. Your office staff twice monthly or so. Your materials are due in 30 days. The overhead expenses are already scheduled. Lease payments are due every 30 days.

Monitor your cash flow budget just like you do your income budget. Go over them at the same time. Usually, when cash flow is becoming a problem it is due to slow paying clients. You need to know that as quickly as possible so that you can chase the money owed to you.

Final Reminder

To run a construction company successfully, you must pay attention to the rate at which your business generates gross profit and the rate at which it spends money on overhead. The only way you can know whether those rates are acceptable as your year unfolds is to create a budget and keep an eye on its progress. Otherwise, you might as well keep expecting those ugly year-end surprises.

Marketing research is a systematic search, gathering and analyzing of the facts and data on how to meet consumer desires and needs. In other words it is a means of gaining information on marketing problem and opportunities. Marketing research also serves the purpose of keeping up with competitors’ market strategies. It is a systematic method of finding new concepts or ideas, getting feedback on proposed advertising or gaining insight into attitudes and opinions about a new product. Marketing Research is also helpful in variety of business decisions and to prepare a credible business plan such as capital planning, cash flow forecast, sales projections, pricing strategy, supplies and number of employees to be hired etc.

Steps in research process:

Marketing research process starts with defining the problem and formulating the research question. The process starts with addressing and determining the organization needs and where to look for the information. Next is to decide on research approach, which is most appropriate for research question and most suitable research method then comes the plan for process of conducting research, after the research is conducted the final step will be analyze and report the finding and recommendations.

1. Define the problem and determine and formulate the research question: If you are considering conducting Marketing research chances are you have already identified a problem or the research question. To be effective, a research study must be both well designed and narrowly focused, this will help you identify the key terms and concepts you should use when searching electronic databases and print research resources. If the research question is too broad too much information will be obtained and large amount of resulting data will be difficult to analyze and there for of little use to organization.

2. Decide on the sources of information and sample profile: Different sources of data are categorized as primary data that researcher collects and secondary data that already exists. Secondary data can further be classified as internal data which as the name signifies a company already has and external data which must be gathered from other sources. Researcher need to plan the sources well from which information can be obtained.

3. Consider your resource options and select the appropriate research approach:

Next step is to consider your resource options and choose a suitable research approach. The process of primary research starts with whether question calls for descriptive, exploratory or casual research and choice depends whether research question needs to be answered with quantifiable facts and how an organization plans to use the information helps in making an appropriate decision. If the organization wishes to prove a fact about the demographic composition of its customer then descriptive study would be appropriate, but if wishes to find out about falling sales then it will need to conduct exploratory research and casual research will determine the effect of proposed change.

4. Plan the research method: Depending upon how research would be conducted, available Research method will include surveys, focus group, interviews, and observation etc. For example for exploratory research the emphasis is not on sample size but choosing the correct participant and the analysis of information they provide.

5. Conducting the research and collecting the data: There are many methods of conducting the research. Mail surveys are quick and relatively inexpensive, they are ideal for seeking extensive feedback on customer satisfaction or other detailed surveys Telephone interviews allow you to rapidly obtain feedback from customers in a cost-effective. Focus groups are facilitated group discussions where customers and prospects explore a particular topic, usually under the guidance of a researcher. They are useful for gauging customer concerns or for getting their thoughts on potential changes. Personal interviews occur when a researcher interviews a customer one-on-one. This type of research is ideal for getting detailed information on customers’ attitudes or how they perceive products or services. Observing customers at various points of contact in your business provides unbiased feedback about a product or service.

6. Performing data analysis and report the finding and recommendations: When analyzing data, always start from review of your research goals, this will help you organize your data and focus your analysis.

Reporting and presentation, is one of the most important of the steps in marketing research. There are as many reporting styles as there are research reports. As for reporting the results, the level and scope of content depends on to whom the report is intended.

The end products of marketing research are conclusions and recommendations. Data is converted into information and conclusions are drawn, it is this final information which management needs to reduce the risks and uncertainties in management decision making.

 

Marketing research serves marketing management by providing information which is relevant to decision making. To be effective, marketing research has to be systematic, objective and analytical, and final conclusion of the research should meet the objective of the project.