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Improving Your Average Collection Period

Filed under Cash Flow. Fact checked on May 24, 2012.

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Wouldn't it be lovely if your customers paid you faster? While it may sound like a pipe dream, consider these methods for improving your average collection period.

For most businesses, the time it takes to collect on a customer's account is generally the step requiring the most amount of time in the cash conversion period. The time it takes your business to collect your accounts receivable is measured by the average accounts receivable collection period. This average defines the relationship between your accounts receivable and your cash flow.

Your credit policy and credit terms play an important role in the amount of time it takes to collect a customer's account. For example, if your credit terms provide your customers with 30 days to pay their bills, then you should expect that your average collection period will be somewhere around 30 days—maybe longer.

Your credit policy and credit terms can also be used to accelerate and improve your cash inflows. Your efforts to collect on your customers' accounts also have a direct impact on accelerating and improving your cash flow.

Payment and Deposit: The Final Frontier

Payment and deposit is the final event in the cash conversion period. This step involves looking at the way you receive payments from your customers, and continues through to the deposit of their payments into your business bank account. After the completion of this step, the cash paid to you is finally available for you to use.

Working with Mailed Payment

Your customers will likely rely on the postal service for sending you their payment. Typically, a customer waits until the payment due date before dropping the check in the mail. There is nothing wrong with waiting until the last day to send you the check, or for using the postal service. In fact, your customer is just taking advantage of a good cash flow management technique.

For your business, on the other hand, using the postal service to receive your customers' checks can add one to three days (possibly more) to your cash conversion period. Finding ways to bypass the postal service for receiving your customers' payments is a key factor in accelerating and improving your cash inflows in this step of the cash conversion period. There are a number of techniques you can use to accomplish just that:

  • post office box
  • lockbox banking
  • preauthorized checks
  • preauthorized debits

Cutting Time to the Post Office Box

Some of the delay in the postal service is the result of having your mail delivered directly to your place of business. This type of delivery entails some extra sorting so that your mail gets into the hands of the correct mail carrier, not to mention the added time it takes the carrier to actually deliver it to your address. Using a post office box is one way to accelerate the payment and deposit portion of the cash conversion period. It can reduce this delay by one to three days.

Your business can rent a post office box to receive its mail at the post office instead of having it delivered your business address. In a sense, you become your own mail carrier since you're in charge of picking up your mail at the post office box. The post office issues a key to you for opening the box and it also protects the contents of your post office box. Depending on the size of the post office box you rent, and the location of the post office, the annual rental charges range from as little as $40 to $820.

Collecting Payments Through Lockbox Banking

Using lockbox banking—a payment method in which you have your customers' payments delivered to a special post office box instead of your business address—is a common cash flow improvement technique. You probably send money to lockboxes every month when  you pay your utilities, mortgage or other bills addressed to a PO Box.

The difference between this special post office box and a regular post office box is that only your customers' payments are delivered to the box. And instead of  you picking up the payments, the process is much more streamlined:

  • your bank's couriers have a key to the post office box and they remove its contents 
  • they deliver your customers' payments to your bank
  • your bank opens the payments and then processes the payments for deposit directly into your bank account

You just have to check your bank balance to ensure everything's been deposited. 

Depending on the nature of your business, the contents of your lockbox can be removed and processed once a day, or more often if required.

Opening Your Own Lockbox

You can establish lockboxes in several different post offices. A basic rule is that your lockboxes should be set up nearest to your customers to reduce the amount of time between your customers' mailing their payments and the deposit into your bank account. 

Carefully investigate the fees that the post office will charge for the service, and weigh the costs of using a regular post office box against the benefits of faster delivery of funds to your bank.

The Cash Flow Advantages of Lockboxes

Lockbox banking accelerates the payment and deposit portion of your cash conversion period in two different ways:

  1. Cutting down on any postal delays caused by having your customers' payments delivered to your business address. Mail delivered to your place of business entails some extra sorting so that your mail gets into the hands of the correct carrier, not to mention the added time it takes the carrier to actually deliver it to your address. Plus, someone from your business is going to have to take those payments to the bank for deposit.
  2. Shortening the amount of time necessary to process your customers' payments by having your bank open the payment envelopes and deposit them directly into your bank account. Because the payment processing is done at the bank, your customers' payments are received and deposited all within the same day. Doing this work yourself can delay the deposit of the payments anywhere from one to two days—depending on how long it takes you to process your customers' payments for deposit, and to actually make the deposit at the bank.

Lockbox banking is typically used by businesses that receive payments from numerous customers. But don't shy away from lockbox banking just because your business isn't as large as your local utility or cable TV franchise. 

Today's increased automation in payment processing has allowed banks to reduce the cost of their lockbox banking services enough to make it economical for businesses of any size. Since most banks will customize their lockbox banking services and costs to fit your specific needs, contact your bank for more information.

Collecting Payments Through Preauthorized Debits

Preauthorized checks aren't in wide circulation and have, generally speaking, given way to electronic forms of preauthorized debits. Yet, they might be in your sweet spot.

These are checks you write on behalf of your customers to pay the amount owed to you. No action is required on the part of your customers if you use preauthorized checks—they don't even need your customers' signatures. On the dates your customers' accounts are due, either you or your bank will write the checks for the amounts due, and then deposit them into your bank account.

Because signatures are not required on the preauthorized checks, you must have your customers' approval prior to withdrawing the funds from their checking accounts. This approval is granted by a signed agreement between you and your customers that allows the preauthorized checks to be used and drawn against their accounts. To your customers, the preauthorized check is just like any other check. The preauthorized check will appear on their bank statements like any other handwritten check. A preauthorized check should also be included as a canceled check along with the rest of their checks.

Cash Flow Advantages for Preauthorized Checks

Preauthorized checks offer many cash flow advantages to you:

  1. They reduce the payment and deposit portion of your cash conversion period by eliminating the need for your customers to write and mail checks. A typical customer will wait until the payment due date before dropping their check in the mail. Preauthorized checks allow you to deposit your customers' checks on the due date of the payment, instead of having to wait for it in the mail.
  2. They eliminate the risk of any potential postal service delays in delivering your customers' payments. Depending on the locations of your customers, not having to rely on the postal service for the delivery of their payments can reduce your cash conversion period by one to three days.
  3. They ensure your customers never pay late since you write the check for them on the date their payment is due. This assurance makes your cash flow more predictable and easier to manage.

Preauthorized checks are often used by businesses that receive payments from their customers at the same time and for the same amount each month. Preauthorized checks are typically used to pay mortgage and other financing obligations, insurance premiums, utility payments, and payments for many other services.

Accepting Preauthorized Debits

Preauthorized debits are "paperless" checks that allow you to receive payments from your customers electronically. They also provide a direct deposit of your customers' payments into your account electronically, all in the same transaction. Preauthorized debits are processed using the electronic funds transfer system (EFTS).

This electronic system eliminates the check-processing steps for both you and your bank. Once you've received the necessary authorization from your customers, your bank prepares a computerized list of your scheduled customer payments. The computerized list contains the information required to carryout the electronic transfer of the funds from your customers' accounts for deposit into your account.

Cash Flow Advantages for Preauthorized Debits

Preauthorized debits offer many cash flow advantages:

  1. They reduce the payment and deposit portion of your cash conversion period by eliminating the need for your customers to write and mail checks. A typical customer will wait until the payment due date before dropping their check in the mail. Since a preauthorized debit payment is made electronically, no check is required.
  2. They eliminate the risk of any potential postal service delays in delivering your customers' payments. Depending on the locations of your customers, not having to rely on the postal service for the delivery of their payments can reduce your cash conversion period by one to three days. 
  3. They ensure your customers never pay late since their payment is made automatically for them. Being assured that your customers pay on time makes your cash flow more predictable and easier to manage.

Preauthorized debits are often used by businesses that receive payments from their customers at the same time and for the same amount each month. Preauthorized debits are typically used to make mortgage and other financing payments, insurance premiums, utility payments, and payments for many other monthly services. Even if you don't fall into these categories but often charge the same monthly amount, preauthorized debits are worth exploring.

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