Creating Income and Cash Flow from Write-offs
Payment terms matter. Net 30 can become Over 90 in seemingly no time, and in capital-intensive industries where cash flow is critical to meet varied vendor obligations, minimizing overdue receivables is important work. Often enough, overdue receivables morph into bad debt and most are eventually written off.
The ability to recover this debt becomes a heroic task, not only because it resurrects money thought to be dead and buried, but it also creates income. When bad debt, previously washed from the books, is recovered, it effectively creates a new profit center. How so? Let’s look at the accounting.
Profit Center Accounting
As receivables age, a corresponding allocation for the debt is captured on the balance sheet as a liability, reducing the accounts receivable on the asset side. This debt provision is funded from the income statement by reducing EBIT. As a collection agency, like Metro Group, recovers the receivables in question, the opposite accounting mechanics go into effect which means net income is increased by the recovered assets.
For example, imagine that CarrierCo places a portfolio of $1 million with its agency, which has an average aging of over 180 days at time of placement. This portfolio has a bad debt allocation of 50% or $500,000, and as the agency recovers the full balance, the $500,000 allocation is captured as an increase in earnings on CarrierCo’s income statement.
In this regard, the agency effectively operates as a profit center for your organization. Importantly, the company benefits from higher cash flow resulting from the collections, which improves its balance sheets and reduces debt to fund new investments or cover operating expenses. Few services offer such resounding value and can build a new profit center for your company.
As the ratio of outstanding receivables to revenue increases, it exerts pressure on other financial issues. Take current accounts as an example. Without cash inflow from receivables, payable bills must be paid for through debt of some kind, creating additional expense and straining cash flows. Financial ratios can also be affected, which could impact lending terms and increase the assessed interest rate on loans for investments.
Managing accounts receivable tightly is good business and it can produce demonstrable financial benefits with a top-notch agency at your side. Better cash flow, lower capital costs, and higher bottom-line profits are possible. As the effects of the pandemic persist, the risk of aged receivables turning into bad debt and write-offs increases, but a prudent strategy with the right team will not only mitigate the risk, it will form a profit center.
To learn more about Metro Group’s services, please contact us at email@example.com or visit our website, www.mgmus.com.