Improving cash flow through better debtor management.

9 minutes
hero image

Effective debtor collection is a key component of improving your cash flow and potentially your bottom line too.

Given the cash flow and cost impact of having debtors, it’s important they’re managed well. There are two key elements to managing debtors well.

  • Deciding who to extend credit to.
  • Implementing efficient processes to collect the outstanding debts.

Debt collection is an essential ingredient of effective cash flow management for any business offering their customers credit terms.

Debtors, also known as Accounts Receivable, are people or organisations that owe a business money. This article focuses on customers who owe you money, also known as Trade Debtors. Offering the benefit of credit terms to your customers comes at a cost to your cash flow and your bottom line. If not managed well, these costs can become a significant burden to your business.

Debtors are created when you provide your goods or services to your customers and then instead of receiving immediate payment, you issue an invoice offering your customers time to pay for your goods and services. This benefit is offered in the hope that it generates additional sales or at least keeps sales from going to a competitor who offers delayed payment terms. This is also known as selling on credit. Effectively you’re lending your customer the money to pay for your goods or services. This is where the cost and cash flow issues come into play.

Cash flow.
If I sell $10 worth of goods or services on credit today, I’m owed $10. I don’t have the money to pay for the cost of the goods or services, pay for the running costs of my business, or add to my profit. Effectively, I’m out of pocket $10 which I’d need to fund from my own resources (equity) or borrow and pay interest on.

Tomorrow, if I sell another $10 worth of goods or services on credit, I’m now owed a total of $20, and on day three I’m owed $30.

If I allow my customers 30 days to pay, and I sell $10 every day, I’ll be owed $300 before I receive my first payment of $10. In fact, if my sales are always $10 per day, I’ll always be owed $300 if everybody pays in 30 days.

My cash flow or the amount of debtors I need to fund is dependent on two things:

  •  my level of sales, and
  •  the time it takes my customers to pay.

The more sales I make or the longer it takes people to pay, the more debtors I’ll have and the more money I’ll need to fund them.

Cost of debtors.
Not only does providing credit impact cash flow, it can also impact profits. Six costs to consider before providing credit terms are:

  • Interest costs - if you need to borrow the money to fund your debtors. There may also be other fees for borrowing too.
  • Opportunity cost – you may be able to use that money for other purposes such as paying suppliers earlier for early payment discounts; buying more resources to increase sales; paying back debt or maybe paying a dividend to the owners.
  • Staff costs – paying an employee to manage the debtors, send out invoices, enter invoices into the accounting system, reconcile payments, or follow-up late payments.
  • Recovery costs – such as using a debt recovery service, legal costs for issuing letters of demand, or even court costs.
  • Bad debts – writing the debt off if you cannot get payment from your debtors.
  • Administration costs – accounting system software, stationery, telephony costs and so on.

Given the cash flow and cost impact of having debtors, it’s important they’re managed well. There are two key elements to managing debtors well.

  1. Deciding who to extend credit to.
  2. Implementing efficient processes to collect the outstanding debts.

Credit policy.
Remember, providing your customers with credit is essentially lending them the money, so it’s worth giving some thought to who you’re prepared to lend your money to. This forms part of your credit policy.

If your customer were to borrow money from a bank, they would need to meet the bank’s credit policy, which is based on the three P’s of lending.

1. Person - Who am I lending money to? What is their history? And are they of good character? As a minimum, it would be useful to know their full name, Australian Business Number (ABN) or Tax File Number (TFN), registered and business addresses, and contact numbers. You can run a simple ABN check on the Australian Business Register. You may also wish to ask the prospective customer for references from other businesses that have extended them credit; or you may request permission to undertake a credit search with a credit reporting agency such as Illion or Equifax (NB Information services are likely to charge a fee for more detailed information).

2. Purpose – While it’s obvious the customer needs credit to purchase your goods or services, it’s also important to understand what they intend to do with them. Are they going to be consumed in the customers operations? Are they to be on sold? Will they to be stored for a time and, if so, where?

Knowing what happens to your goods and services, where they’re stored and how long before they’re used, can help determine if your goods or services could be recovered in the event you’re not paid.

3. Payback – Where will your customer get the money to pay you? This may be from on-selling your goods and services, normal business trade, sale of assets, other income sources or maybe they’ll need to borrow the money. This also links back to the Person and how likely they’re to pay you.

If you’re extending credit to your customers, it’s important to detail your credit policy to them and ensure they understand and accept it before making the sale.

As well as getting to know who you’re lending your money to, here are some other details that may be useful to include in your credit policy. This list is not exhaustive and not all the items may apply in your particular business or industry but use it as a starting point for considering the policies best suited for your business.

  • Payment terms: When do you want your customer to pay you? Do you want a deposit up front, payment on delivery, or payment based on days after receipt of the goods or services, or receipt of invoice, or end of month?
  • Payment Methods: How do you want your customer to pay you? Cash, electronic transfer, credit card, BPAY® or other payment methods? Include any fees you may charge for the payment method chosen.
  • Limits: Do you wish to place a limit on the amount of credit you will provide to a customer?
  • Discounts for early payment. If you wish to incentivise your customer to pay sooner, you may offer a discount for early payment. It’s important to clearly define in your policy how the discount is earned, calculated, and applied.
  • Late payment fees. To incentivise your customer to pay on time you may consider charging a late payment fee. Ensure it’s reasonable and that your policy clearly defines how the fee is calculated, and when it’s applied.
  • Recoupment of costs. In the event that you need to take action to recover any outstanding debts it’s prudent to include the recoupment of any reasonable expenses in your policy.
  • Disputes. It’s a good idea to include the process to be followed should a customer dispute the amount owing.
  • Communication. Detailing the preferred methods of communication and providing your contact details helps to support the lines of communication between you and your customer.

The level of detail required in your credit policy will depend on how large you expect your transactions to be and what difficulties you anticipate when collecting from your customers. This will be influenced by the size of your business and the industry you operate in.

Also, keep in mind that your customer may wish to negotiate different terms, particularly if they have their own systems for paying suppliers. As part of the negotiation, you may wish to change your pricing if the proposed changes impact your costs.

Once terms are agreed it’s now important to ensure those terms are adhered to and you’re paid on time. Here are some hints and tips to help make this happen.

  • Invoice promptly. Issue your invoice on the day of sale or on delivery of the goods or services if possible. Every day later an invoice is issued may add an extra day or more to you getting paid.
  • Implement a reminder service. Proactively reminding your customer before their payment is due may be helpful in getting paid earlier or prompting on time payment.
  • Offer a range of payment options. Not everyone operates in the same way, so by offering a range of ways to pay you make it easier for your customer to fit payment of your invoice into their way of working. There are a number of different electronic payment methods available that make collecting payments more efficient and more secure.
  • Follow up. The day after the agreed day of payment, follow up with your debtor. Preferably by phone or in person, as emails may be more easily ignored. It’s recommended this is a friendly contact, training your customers that the terms agreed are how you expect to be paid. If they cannot pay, follow the procedures agreed in your credit policy or negotiate new payment arrangements.
  • Issue accurate invoices. Cross your t’s and dot your i’s, ensure your invoices are correct. Encourage your customers to follow the dispute process in your policy if it’s not correct which may help you to identify where the inaccuracies are. You might even consider proactively contacting your customers to check they’re satisfied with the goods or services received and confirm that their invoice is correct to forestall any possible disputes.
  • Contact the right person. Particularly in large organisations, the person who processes the payments may not be the person who approves the payment. Understand your customers’ process for paying you and know the right person to contact to get your invoice paid if it’s overdue.
  • Review your aged debtor listing regularly. It’s important to know who your outstanding debtors are, how much they owe, how long they have been outstanding, why they’re overdue and any plans in place to receive payment.
  • Outsource collections. If you don’t have the capacity or ability to collect your debtors, you may wish to engage a collection agency to do this on your behalf. A key consideration here though is that they may not treat your customers the same way you would, potentially damaging a relationship and jeopardising future sales. Another alternative is to sell the invoice(s) for someone else to collect. In this instance the sale is often at a discounted price, so you won’t receive the full amount however you get your money sooner and don’t have any further collection costs.
  • Debtor finance. Even with all the effective systems and practices in place, sometimes cash flow can still be a concern. This is where debtor or invoice financing may help. This type of finance allows a bank or finance company to lend money against your outstanding invoices and is repaid when your debtor pays their invoice. Interest and fees, and terms and conditions, will usually apply.

With a good understanding of the impact of debtor collection on cash flow and profit, and the right policies and procedures in place, a business can reap the benefits of extending credit to their customers to potentially increase or maintain sales.

There are many ways that Westpac can help with payment collection. Click here if you’d like to know more.


This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness for the information to your own circumstances and, if necessary, seek appropriate professional advice. ©Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian credit licence 233714.

author thumbnail image

Rob Lockhart

Rob has helped thousands of people and organisations improve their financial confidence. His career started almost 40 years ago working with a mid-tier accounting firm. From there he moved into banking and has worked with people and organisations. As a CPA grounded in the realities of finance, he brings a unique insight and understanding to the numbers behind our lives.

Was this helpful?