Tag Archives | collections

Retainage

Retainage Definition

What is retainage? What is a retainage fee? In the contracting business, vendors define this term as a portion of the payment that is withheld until the completion of a project. The client doesn’t pay the contractor remaining payment until all work on the project is complete. It is defined the risk clients take when paying contractors. Its result is a protection for their money, time, and other resources.

Negotiate retainage upfront and represent it as a percentage of the overall cost of the project. A common withheld payment amount is 10%. This incentivizes the contractor to provide quality work up until the very end of the project. As a deal-sweetener, or for small scale projects and rushed jobs, a client may offer to forego this percentage to a familiar and reputable contractor. This definition can vary somewhat depending on industry and company focus.

Retainage Collection

Similar to accounts receivable and other forms of trade credit, an uncollected retainage receivable is essentially an interest-free loan with a cost equal to the cost of financing current assets and the time value of money.

Therefore, from the contractor’s perspective, a shorter collection period is optimal. Typical collection periods for retainage accounts receivable can be as long as 6 months or as short as 45 days. If you want to be very efficient, then consistently collect the withheld amount from clients within 90 days of project completion. A reduction is surely needed if collection occurs beyond the marker of 6 months.

Collection Hurdles

Typically there are three steps to complete before the contractor can collect retainage. These three steps are: completing the punch list, putting together the close-out package, and submitting this invoice.

Define a punch list as a list of minor details and leftover items related to the project. The bulk of the project may be complete, but small tasks may remain unfinished. For instance, a punch list may include an unpainted portion of a ceiling, faulty wiring for a light bulb, or a problem with plumbing. The client will not pay the retainage until these minor items have been taken care of, so this is an important step to complete in speeding up collections.

The close-out package is a collection of documents related to the project. Some clients, especially in the medical field, expect a close-out package prior to paying retainage. The close-out package consists of copies of legal documents, liens, warranties, certificate of occupancy, test results, operations and maintenance manuals, and other relevant paperwork and documentation. Gather these documents and send them to the client in a timely manner to ensure prompt payment of retainage.

And finally, it is important to submit the retainage invoice to the client as soon as possible after all other necessary steps have been completed. Prior to submitting the invoice, finalize all subcontractor pricing.

Three Steps for Retainage Collection

1. Complete the punch list
2. Assemble the close-out package
3. Mail the retainage invoice

Complications

Certain matters can complicate retainage negotiations, retainage collection, and retainage release. These issues can arise from change orders and arrangements with subcontractors.

Often, over the course of a contracted project, the client will request changes deviating from the original project plans. For instance, in a construction project the client may request to move a wall, alter or relocate windows or doorways, or add or change other features. These change orders inevitably add to the cost of the project as a whole and change the amount withheld.

Getting pricing in from all subcontractors on additional work can be difficult. A project manager must rely on subcontractors to submit pricing in a timely manner so that they can generate the final progress billing and retainage billing. Oftentimes, pricing can snowball at the end of a project.

A dedicated project manager will be pro-active with regards to pricing from subcontractors. So that he may invoice the retainage as soon as possible after they complete the project.

Retainage bonds further confuse the matter, with needs varying by location and governing body. Generally, file some kinds of retainage bond with the local municipality. Amounts and requirements are subject to the preferences of local government. Make sure to consult an expert when filing for any type of payment bond.


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retainage

See Also:
Progress Billing for a General Contractor
How to Maintain an Effective Job Schedule
Work in Progress
How to manage inventory
Trade Credit

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Net 30 Credit Terms

See Also:
How Important is Personal Credit in Negotiating a Commercial Loan
How to Improve Your Credit Score
Letter of Credit
Line of Credit (Bank Line)
How to collect accounts receivable

Net 30 Definition

What is 2% 10 net 30? Or 1% 10 net 30? The credit terms 2% 10 net 30 means the customer gets a 2% discount if the bill is paid within 10 days. Otherwise, the full amount of the bill is due in 30 days. Net 30 credit terms represent incentive discounts that suppliers offer to encourage buyers to pay promptly. When a product is sold on credit, the supplier delivers the product to the buyer and the buyer agrees to pay for it later. Additionally, net 30 credit terms means 30 days before a penalty for late payment is accrued. It is a mainstay in business to business sales.

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Net 30 Credit Terms Explanation

For those who have just heard about net 30, explanations are needed to understand why it is so commonly used. Net 30 payment terms, with a discount for early payment, induce the buyer to pay earlier. According to the net 30 definition, the total amount of the bill is due in thirty days, but if the buyer pays earlier, the buyer will get a discount of 1% or 2% of the bill, depending on the net 30 payment terms.

Credit Sales

To understand 2 percent 10 net 30 payment terms requires an initial understanding of credit sales. Sales made on credit are essentially like offering an interest-free loan to the customer. In this sense, it represents a cost to the seller and motivates the seller to try to collect receivables as soon as possible. It also represents a benefit to the customer, who is motivated to postpone payment as long as possible. When a customer can hold onto cash it owes to a supplier, the customer is benefiting from an interest-free loan from the supplier via the credit sale. Net 30 vendors bridge the gap between the benefits of trade credit and the disadvantages of slow AR turnover.

Average Collection Period

The average length of time it takes a company to collect payment for credit sales from customers is called the average collection period. A shorter collection period shows a company that is able to collect its receivables quicker and thereby reduce the implied cost or opportunity cost of the interest-free loan to the customer. On the other hand, a company that has a comparatively long average collection period is clearly having trouble collecting payments from customers and this could be a sign of inefficient operations. 2% 10 net 30 days can be one of the many solutions to alleviate this problem.

Net 30 Credit Terms Calculation

For net 30, calculators are not necessary when you understand how the system works. If the buyer decides not to take advantage of the 2% discount by paying within ten days, the buyer is essentially paying 2% interest for the benefit of holding onto the cash for 20 more days. When considered in this way, the buyer’s cost of foregoing the discount amounts to about 36.5% per year. This is because the buyer is essentially paying 2% interest on a 20 day loan; there are 18.25 twenty-day periods in a year; so 18.25 multiplied by 2% equals 36.5% per year (36.5% = 2% x (365/20) . Likewise, by foregoing the 1% discount offered for payment within 10 days is costing the buyer 18.25% per year.

36.5% = 2% x (365/20)

18.25% =1% x (365/20)

So, even if the customer doesn’t have the cash on hand to pay the bill within the 10 day window, as long as the customer can obtain cash for a borrowing cost less than 36.5% (for a 2% discount) or 18.25% (for a 1% discount), that customer would be better off borrowing the money to pay the bill early so as to benefit from the discount offered by the credit terms.

Net 30 Credit Terms: Example

When thinking about the 2% 10 net 30 meaning, an example provides perspective into the idea. Let’s say a manufacturer sells widgets to a retailer for $1,000 and the manufacturer offers the retailer credit terms 2% 10 net 30. The retailer can get a 2% discount on the total bill if it is paid within ten days. In this case, the total net 30 invoice, after the discount, would be $980 and the retailer would save $20.

$980 = $1,000 – (2% x $1,000)

If the retailer foregoes the discount, the full amount of $1,000 will be due at the end of the thirty day period. In this case, the retailer essentially paid (or gave up) $20 in order to postpone payment for 20 days. Hypothetically speaking, if the retailer were to pay $20 dollars in order to postpone payment for every 20 day period in a year, then that would amount to a total yearly cost of $365 ($365 = $20 x (365/20)). Under most circumstances, when offered credit terms 2% 10 net 30, it is in the customer’s best interest to take advantage of the discount and to pay early. Net 30 accounts provide benefit to both the vendor and client.

For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

Net 30 Credit Terms

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Net 30 Credit Terms

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Credit Sales

See Also:
Trade Credit
5 Cs of Credit
Collateralized Debt Obligations
Cash Flow Statement
Balance Sheet

Credit Sales Definition

In accounting, credit sales refer to sales that involve extending credit to the customer. The customer takes the product now and agrees to pay for it later. Credit sales are a type of trade credit. They create receivables, or moneys owed to the company from customers.

Credit sales terms often require payment within one month of the invoice date, but may also be for longer periods. Many companies offer discounts for early payment of receivables. For many companies, all of their sales are credit sales. Most of the commercial transactions between businesses involve trade credit. Trade credit facilitates business to business transactions and is a vital component of any commercial industry.

Sales made on credit are essentially like offering an interest-free loan to the customer. It represents a cost to the seller and motivates the seller to collect receivables quickly.


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Credit Sales and Average Collection Period

The average length of time it takes a company to collect payment for credit sales from customers is called the average collection period. A shorter collection period shows a company that is able to collect its receivables quicker. In addition, it shows they reduced the implied cost or opportunity cost of the interest-free loan to the customer.

On the other hand, a company that has a comparatively long average collection period is clearly having trouble collecting payments from customers and this could be a sign of inefficient operations.

Credit Sales Example

For example, if a widget company sells its widgets to a customer on credit and that customer agrees to pay in a month, then the widget company is essentially extending an interest-free loan to the customer equal to the amount of the cost of the purchase.

As long as the customer puts off paying for the purchase, the widget company is paying interest on loans that are tied up in the accounts receivable account due to the sale that was made on credit. In this sense, the widget company is paying interest on the customer’s loan.

The widget maker would be better off trying to get the customer to pay as soon as possible. To do so, the widget company may offer a discount to the purchase price for early payment. For example, the widget company may offer its customers a deal like 2% ten, net thirty. This deal states that the customer gets a 2% discount if they pay within ten days, otherwise they pay the full amount in thirty days. The 2% discount, when calculated out as yearly savings, turns out to be quite a substantial discount and a powerful incentive for the customer to pay early.

credit sales

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Credit Memorandum Definition

See Also:
Debit Memorandum (memo)
Credit Sales
Account Reconciliation
Chart of Accounts (COA)
Transaction Exposure
General Ledger Reconciliation and Analysis
Debt Compliance 101: Keeping Your Banker Happy

Credit Memorandum Definition

The credit memorandum definition or memo is a form or document, sometimes called a credit memo invoice, that informs a buyer that the seller will be decreasing or crediting the amount that the buyer owes in accounts payable, thus decreasing the amount of accounts receivable in the seller’s account.

Credit Memorandum Meaning

A credit memo is often issued when a seller has made some sort of mistake, or extenuating circumstances have been brought to light which require an adjustment towards a sale. Credit memos from a bank are usually in regard that a bank if reversing some sort of transaction in which the bank made a payment it should not have, or the bank may have made a collection upon a note receivable or a certificate of deposit. When the latter occurs the bank will transfer the collection of funds into the depositor’s account.

Credit Memorandum Example

For example, Cindy works for Fluffy Stuffs Inc. as a part of its sales staff. The company has recently sent an order to Toys N’ More for a price based upon last month’s prices. Cindy just received the new prices the sales staff is supposed to charge customers. These prices are much lower than the past due to a drop in the market price for stuffing. Therefore Cindy sends a credit memo form to Toys N’ More informing them that they should reduce the amount that they owe to Fluffy Stuffs. Fluffy Stuffs will also reduce its accounts receivable by the same amount.

credit memorandum definition

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Cash is in Your Business

See Also:
Cash Flow After Tax
Cash Cycle
Financing A Startup Company
How to Collect Accounts Receivable
Monetize
How to Develop A Daily Cash Report
Cash Flow Statement

Cash is in Your Business

I received a call from a desperate prospect, Sue. As always, I started asking questions about the business. To begin, I asked “Is your business growing?” She answered “Yes”. Then I asked her “What does your business need?” Frustrated she answered I NEED CASH. My next question was “Why do you need the cash, Sue?” Frustrated more than ever she replied “TO PAY MY BILLS!”

Two Sources of Cash

Seeing I was about ready to lose her in frustration I ask “Where does the cash come from in your business?” She responded calmly “What do you mean?” I responded there are two sources of cash for your business; internal and external. I continued by telling her we need to understand the cash source to determine and solve the problem. That is the only way we can ultimately get you the cash in the most cost effective way to satisfy your needs, paying your bills.

She then said “I still don’t understand your comment about internal and external?” I told her that internal cash flow in a growth business is generated by selling your goods or services at a profit. I then asked her what she sold in her business. She told me she manufactured products and sold them to large retail stores. I asked a couple more questions about her profit margins and satisfied myself that her margins were more than adequate.

A/R Collections

Then I asked her about her accounts receivable collection efforts and inventory management. She asked me “Why would you care about that?” Not waiting for a response she continued “I think I need a larger line of credit from my bank and they do not seem to be interested.” Increasing your line of credit with the bank may not be the most cost effective way to solve your cash flow needs. I asked her again about her accounts receivable collections and inventory management. Reluctantly, she told me that her receivables are past due, she is at her maximum credit line with her suppliers, and she does not have inventory controls.

Now that I understood her situation, I showed her that speeding up her accounts receivable collection process, and managing her inventory would allow her to get her suppliers back within their credit terms, and pay down her line of credit at the bank. The combination of these three results gave her the operating capital she needed to continue her growth for an estimated six months. Therefore, we could pursue external cash sources without the pressure of having to make a decision today. Start with knowing that cash is in your business.

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Accounts Receivable Collection Letter

See Also:
Collect accounts receivable
Why Use a 13-Week Cash Flow Report as a Management Tool?
Unlock Cash in Your Business

Accounts Receivable Collection Letter

Always send reminder and collection letters. Letters combined with calls can help speed up your collections! Trigger points for letters may be as follows:

Balance at 30 days receives a reminder letter. Then balance at 60 days receives a harsh collection letter and credit hold. Then balance at 90 days receives attorney letter. Finally, balance at 110 days turned over to collections.

The number of collection letters in a series should be kept to a minimum. Experienced commercial credit grantors have found that there is a point of diminishing returns, generally reached after the first letter goes unanswered.

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Example of Accounts Receivable Collection Letter

Remind Letter Example A:

January X, 20XX

Dear Company A,

This is a friendly reminder that your account has a past due balance of $X.xx. Attached are the invoices we show to be unpaid; please check your records and if you find that these have already paid, please contact me at 713-555-5555.

If we do not hear from you or receive payment within 10 days from the date of this letter, your account will be put on credit hold and no further services will be provided until all overdue balances are paid in full.

Thank you for your prompt attention to this matter.

Sincerely,

Collections Representative

A reminder letter, signed by the accounts receivable (AR) collections representative, once a balance has reached 30 days old and a subsequent, harsher collection letter when a balance reaches 60 days can produce desired results. Should the harsh collection letter not produce results, an attorney letter may be in order as well as the services of a collection agency. The following example is of a harsh collection letter which should be signed by the company’s controller.

Remind Letter Example B:

February X, 20XX

Dear Company X:

We show your account has a past due balance of $X.xx. Previous attempts to collect the balance have failed and as a result, I have been forced to put your company on credit hold. Please call me immediately at 713-555-5556 to resolve the balance on your account and to avoid having this issue referred to a collection agency.

Sincerely,

Controller

Managing accounts receivable and collecting on-time is just one of the many ways to improve cash flow. The next step to improving cash flow is to download the free whitepaper, 25 Ways to Improve Cash Flow.

accounts receivable collection letter

accounts receivable collection letter

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