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What Are the True Carrying Costs of Accounts Receivable?

carrying cost of accounts receivable

Managing accounts receivable is a challenge for most SMEs. While invoicing customers for products and services can simplify transactions, this comes at cost. In addition to waiting for invoices to be paid, there are other costs such as administration. Here we’ll break down the cost to create a clear picture of the costs of carrying accounts receivable.

The key problem with offering invoice payment terms

Many SMEs offer invoice payment terms when selling to other businesses because it helps them sell more, their customers expect it, and their competitors do it. Despite facilitating trade, offering invoice payment terms can create problems for business owner, and managers. 

The biggest of these is late payments. Research commissioned by Moula revealed that 65 per cent of their customers don’t pay on time and 40% pay later than 30 days. Nearly two-thirds of the SMEs surveyed said that late payments negatively affect their cash flow. 

Besides the cash flow problem, there are additional costs associated with late payments. These include time, administrative, opportunity, predictability, financing and bad debt. Let’s take a closer look at these.

Time and administrative costs of accounts receivable

Business owners and staff spend large amounts of time managing accounts receivable, which includes calling and emailing customers, and updating accounting records as payments are made. While some of this can be automated, there’s still a cost. 

Research presented in The Harvard Business Review (HBR) estimated that time and administrative costs amount to 0.82 per cent of the invoice amount at 30 days, 2.13 per cent at 60 days, 3.94 per cent at 90 days and 5.22 per cent at 90 days.

Opportunity costs of waiting for payments

The opportunity cost represents the cost of lost opportunities by not having money owed in hand which could be invested to grow the business. The formula to calculate this is:

[(Accounts receivable x Rate of return)] ÷ 365 x Debtor days

The HBR research estimated the opportunity cost of accounts receivable is 2.5 per cent of the amount outstanding at 60 days, 7.50 per cent at 90 days and 12.50 per cent at 120 days. (Also, see What are Debtor Days and How to Calculate Them?)

Financing costs of accounts receivable

Businesses borrow money to cover working capital shortages while waiting to be paid. This amount will depend on the interest rate of the finance used to cover shortages. According the HBR research, the cost of financing outstanding accounts receivable is 0.66 per cent at 60 days, 1.30 per cent at 90 days and 1.99 per cent at 120 days. Many SMEs end up taking out business loans to overcome working capital shortages resulting from outstanding receivables.

Bad debt and predictability costs of accounts receivable

There’s always the risk of not getting paid some debts outstanding as accounts receivable. Some SMEs suffer from poor cash flow and have trouble paying their bills. This results in late invoice payments or non-payment if the business fails. The longer an invoice goes unpaid, the greater the chance it will turn into a bad debt. This is supported by the HBR article that shows the increasing bad debt cost of carrying accounts receivable over time. These costs are 1 per cent at 30 days, 4 per cent at 60 days, 6 per cent at 90 days and 10 per cent at 120 days.

Predictability costs will differ for each company, depending on the consistency of collections. This relates to the chance of being paid by each customer. In the HBR research, this number was 1.0 per cent at 60, 90 and 120 days, meaning there is a 1 per cent chance of not getting paid. 

Learn more about bad debt in Bad Debt and How to Avoid It.

Calculating the cost of carrying accounts receivable

Here are the cost estimates for accounts receivable by their ageing stage according to the research in the Harvard Business Review.

table showing carrying costs of accounts receivable

If we take a snapshot of a business that has $50,000 receivables between 30 days and 120 days, with $20,000 at 30 days, $15,0000 at 60 days, $10,000 at 90 days and $5,000 at 90 days. If we add up all the costs for this figure, we get: 

1.82% x $20,000 + 10.29% x $15,000 + 19.74% x $10,000 + 30.71% x $5,000 = $5,417

As a percentage of the outstanding accounts receivable, the cost is nearly 11 per cent of the total. It’s an ongoing expense that adds up to thousands of dollars each month.

Ways to reduce the carrying costs of accounts receivable

There are ways businesses can cut the costs of accounts receivable. These include: 

  • Documenting credit policies and procedures – having clear policies and procedures in place will help filter out risky clients
  • Clearly communication payment terms – customers should understand payment terms and conditions
  • Invoice regularly – instead of invoicing monthly, invoice when products or services are delivered.
  • Make it easy for customers to pay – include payment options such as electronic funds transfer, credit card, PayPal and cheques. 
  • Automate accounts receivable – sending automated reminders will save time and money, and speed up invoice payments. 

A new solution for reducing or eliminating accounts receivable costs

Businesses that sell to other businesses and offer invoice payment terms often experience cash flow problems when waiting to get paid. At the same time, business purchasers lack the cash flow to make large purchases. Moula Pay is a solution that solves the cash flow gap for both buyers and sellers of products and services for business. 

If you sell to other businesses and your customers pay with Moula Pay, you get paid upfront. At the same time, your customers have up to 12 months to pay, with the first three months interest and repayment-free.

Become a Moula Pay Merchant to:

  • Get paid upfront – give your customers excellent payment terms that improve your cash flow.
  • Stop chasing payments – outsource the pain of chasing invoices, and let Moula take the risk of unpaid invoices.
  • Sell more, more often  – giving your customers access to more funds means they can spend more with you.
  • Reduce or eliminate the cost of accounts receivable – if you choose to use Moula Pay for all your customers, then none of the costs mentioned in this article will apply to you, as you have completely outsourced your accounts receivable. You would even eliminate the risk of bad debt because this is assumed by Moula Pay. 

Learn more about how Moula Pay can give your customers great payment terms, improve your cash flow, and save you from chasing late payments.

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All the thoughts, ideas and musings from the Moula team! Covering everything from work/life balance to general finance tips plus everything in between!

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