In an effort to promote and increase sales, many businesses offer more generous payment terms. Payment terms have a significant impact on cash flow, since they can impact the return on your accounts receivable.

The following chart illustrates how changing your payment terms can impact your accounts receivable balance.

Any change in payment terms that is implemented in an effort to increase sales must be carefully considered with regard to the possible impact on accounts receivable. It is a valid assumption to expect all your accounts to take advantage of more generous terms, not just the new sales arising from the change.

Importance of the Collection Period

It stands to reason that the longer your invoices remain outstanding, the higher the average outstanding balance in your accounts receivable will be. This is cash that could otherwise be paying down debt or used elsewhere in the operation of your business.

Although carrying accounts receivable is, in most cases, a necessary part of doing business, what comes as a surprise to many is the dramatic improvement in cash flow that can be realized from shortening the average collection period by just a few days. The following example illustrates this point.

If a company has annual sales of $5 million (average sales per day = $13,900), and an average collection period of 45 days, accounts receivable will average $625,000 ($13,900 x 45 days). Reducing the collection period by just five days will free up over $70,000 in cash flow, and save in excess of $5,000 in interest costs (e.g. 7%) over the course of a year!

The following chart shows the significant improvement in cash flow arising from shortening the collection period by varying amounts at different sales levels