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Carrying Costs of Your Accounts Receivables

Updated on :  

08 min read.

Managing accounts receivables is a challenging task for most small and mid-sized enterprises. Although invoicing customers can streamline the transactional process, additional costs come. 

Carrying Costs of Accounts Receivables

Bad Debts

All sales on open account terms carry an associated risk of non-payment. It might be the result of a legitimate disagreement. The longer the delay in paying an invoice, the more chances of it turning into bad debt. Nonpayment of large amounts often arises from filing bankruptcy protection by customers.

Opportunity Costs

Opportunity costs refer to the cost of opportunities that a business could not seize due to a lack of funds. The opportunities could include business expansion, new product development, internal improvements such as overhead or salary increases, etc. Opportunity costs can be calculated by using the below-mentioned formula:

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

Miscellaneous Costs

The following expenses can be included under miscellaneous costs:

  • Inability to discount. This is especially vital in a high-interest period.
  • Penalty/late fee charges. This is in addition to potential restricted credit.
  • Increased risk factors. The older the debt becomes, the harder it gets to collect it. 
  • Managing administrative functions.
  • Handling bookkeeping operations.

Financing Costs

Businesses often borrow money to fill working capital shortages while waiting for invoices to get paid. This amount depends upon the interest rate of the finance used for filling the shortages. Many small and mid-sized enterprises take business loans to cover business capital shortages arising from outstanding receivables. 

Administrative Costs

Business owners and employees spend a lot of time tracking and managing accounts receivable. The management process includes calling and emailing customers, updating accounting records upon the completion of payments, etc. While a lot of these tasks can be automated, businesses will still have to pay for the salaries of the credit department employees, management of the annual cost of credit reports, and other ancillary costs of managing credit functions.

How to Reduce the Carrying Costs of Your Accounts Receivables?

  • Establish clear policies and processes to filter out possible risky clients
  • Invoice whenever products and/or services are delivered instead of monthly invoicing.
  • Communicate payment terms and conditions to the customers.
  • Include fast and easy payment options such as electronic funds transfer, credit card and debit card options, cheque payment options, etc.
  • Automate the accounts receivable process as sending automated reminders will help reduce time and money and accelerate the payment process.