Accounts Receivable-Are You Promptly Defusing this Bomb in Hotel Financial Statements?
Have you heard of the Accounts Receivable Incomplete Sale Syndrome?
More importantly, I hope you are not falling victim to that!
It is a warning sign for sure.
It is something on which your hotel owners are keen that you heed that warning sign.
What syndrome am I talking about and what warning sign?
I will lay out a strong case for you to avoid getting into the situation.
And save yourself aggravation!
This Blog Post will cover:
Accounts Receivable - The Incomplete Sale Syndrome
Have you heard of the Incomplete Sale Syndrome?
If not, let me explain.
An unwritten rule in business is about the sale process remaining incomplete in certain situations.
It is the assertion that sale or revenue earned is not considered complete until the money is in the bank.
This means making the sale is not the end of the process.
There is one more critical step to be taken.
A step that literally determines whether your sale has been successfully completed.
As in when you get paid for the sale.
And money safely in your hotel bank account.
On the other hand, until that money from the sale is banked, it is considered an incomplete sale.
That simply is the Incomplete Sale syndrome.
That incomplete sale is commonly known in business terms as Accounts Receivables.
A process that began with pitching the product or service to the customer through making the sale is consummated with the collection of money and banking that.
Accounts Receivable - Why a Bomb?
Why is it critical that a sale is only complete when money is in the bank?
And why am I calling accounts receivable a bomb?
Let me explain.
A big chunk of hotel sales or revenue is not received in cash immediately.
In fact in this internet age of credit cards and electronic transactions a majority of the sale or revenue is deferred to different degrees.
Deferred until collected that is.
This process during which the deferment takes place is that accounts receivable we talked about earlier.
Accounts receivable comes in various flavors.
Each flavor is linked to how quickly the sale is converted to cash received.
EXAMPLE
For example, credit cards are the closest to cash in the collection process.
Most credit cards charged upon hotel checkouts by guests are collected within 48 hours.
A few credit cards may take longer.
Now just consider this scenario.
Your hotel earned a revenue (made sale) of $2.5 million dollars yesterday.
Your cash sales was $30,000.
That means $2,470,000 is sitting as accounts receivable to be converted into cash.
Now can you see how it is a bomb.
Unless the money for the sale hits the bank account that sale is not complete.
And if 99% of your sale is incomplete that is indeed a bomb.
But the bomb can be defused.
How you ask?
Hang on I am getting to that.
Accounts Receivable Types
Accounts receivable as I said earlier comes in different flavors.
Almost all hotels anywhere in the world must be getting upwards of 70% of their sale paid through credit cards.
This is the reason why hotels sign up with reputed credit card companies.
To ensure that cash is collected swiftly.
And without any stumbling blocks (we will see this later in the post).
So that sale and revenue can be considered complete.
That is as far as credit cards are concerned.
Some other flavors of accounts receivables can be real ticking time bombs.
What do I mean by that?
Remember what I said earlier.
Credit cards are the closest to cash in the collection process.
Some other forms of accounts receivable could be when the hotel provides credit to travel agents or companies who booked business with them.
These forms of accounts receivable are normally paid over a 30 day period.
Notice the word “normally.”
This is linked to that 30 day period I talked about.
That 30 day period is also known in business circles as the Credit Term.
In other words, the hotel is approving that the travel agent or company can pay the hotel invoice within 30 days from the date the guest checked out.
Now, do you notice how the 48 hour period for a credit card accounts receivable has suddenly now gone 30 days away.
The bomb is ticking.
Why so?
I am coming to that.
Accounts Receivable - 3 Sources of Danger
In the hotel industry, the accounts receivable bomb has 3 major sources of danger:
- Incorrect / delay in invoicing by the hotel
- Delay in collection by the hotel
- Credit approved by hotel without due diligence
Let me briefly state what each of these sources of danger mean.
First, your hotel may have made an error in its invoicing.
Errors can be as simple as incorrect address of the travel agent or company.
Or it can be all the way to serious errors like incorrect or disputed amounts.
Or big delays in submission of invoice to the travel agent or company.
Second, if invoicing has been correct and on time, follow up measures taken to collect the amount may not have been taken.
Or follow up is delayed majorly.
Both these types are errors in most cases may only delay the payment beyond the 30 day period.
So, the bomb continues to tick.
However, the chances that it will detonate are low.
It is the third source of danger which is not only a ticking time bomb but one with a short fuse.
And likely to detonate most probably.
That source of danger is credit approved for a travel agent or company without due diligence.
What is due diligence?
It is a process which ensures that the hotel has taken all measures to guarantee that the amount of credit granted is secure.
That the travel agent or company will pay the amount within the credit period.
It is a protective measure for the hotel’s accounts receivable.
How Can You Identify the Danger in Your Accounts Receivables?
So, how will you know your accounts receivables are in danger territory?
Well, the most common way is what is known in the industry as the Accounts Receivable Aging Report.
The Accounts Receivable Aging Report lays out the amounts due to the hotel.
This is categorized according to the number of days they have been outstanding.
The common categories are:
- Current
- 30-60 days
- 60-90 days
- 90-180 days
- Over 180 days
This report is normally printed at the end of each month.
It is part of the Balance Sheet Schedules.
The Current is simply the first 30 days from date of invoice.
If you remember, we learned that the normal credit period granted by hotels is 30 days.
When an outstanding reaches 60-90 days, warning bells should have already started ringing.
The Ticking Time Bomb Categories
The last two categories (in red) are where warning turns to the ticking time bomb I talked about.
It is important that the hotel ensures that the three sources of danger I talked about are taken care of.
If the hotel did that, they should have little or no outstanding amounts in those last two categories.
In particular, the hotel must ensure that danger source one is strictly ruled out - accurate and timely invoicing.
Regular follow ups by the Credit department with the debtors (those travel agents or companies owing money to the hotel) is mandatory.
When the outstanding reaches the 60-90 days, the hotel must ensure that no future credit is granted for that travel agent or company.
Why should you do that?
Well, you do not want to repeat the earlier mistake.
A good way to rule out danger source one and two is to ask the travel agent or company to confirm the account balance through a certificate.
Another measure is to check with other hotels and find out if they are owed monies by the travel agent or company too.
If either the travel agent or company is not producing a balance confirmation and / or other hotels seem to be having the same problem, the bomb is now not only ticking but is probably ready to detonate.
This is also the situation which exposes the third category of danger I talked about - granting credit without adequate credit checks.
As a rule of thumb in effectively managing accounts receivables, get on the collection effort even while the outstanding is in the Current aging category.
This give the hotel wiggle room for collection.
Moreover, reputed trafel agents and companies make payments on time - meaning within the 30 day period.
Let us now understand the importance of accounts receivable to a company’s financial position.
Through the Balance Sheet.
Liquidity and Accounts Receivable (Current Asset)
Take a look at the Balance Sheet of Paradise Hotel below.
Paradise Hotel Balance Sheet Current Assets by Liquidity
Notice that Accounts Receivable is shown under Current Assets.
In an earlier section of this post you learned about accounts receivables being an important current asset.
What are Current Assets?
Current assets are those assets which can be converted to cash within a financial year.
They are thus different from Fixed Assets.
Examples of Current Assets (as seen in the Balance Sheet of Paradise Hotel above) are Cash, Accounts Receivable, Inventories etc.
Notice something else.
Accounts Receivable is listed right at the top of the Current Asset categories after cash (and Short Term Investments).
The hotel industry is unique because it is one of the few (probably only as well) industries which lays down the format for its financial statements.
It is known as the Uniform System of Accounts.
This format lays out current assets in the order of liquidity.
Liquidity is a concept which simply tells you how quickly a current asset can be turned into cash.
This is also the reason that Cash is on top of accounts receivable.
It is a current asset already in cash form.
It need not be converted to cash.
However, Other current assets have to be converted to cash.
In that category, accounts receivables are first in line after short term investments.
You might ask a question.
Why are inventories considered less liquid than accounts receivable - since they are listed after accounts receivable.
Great question.
I will address that in the next section.
How is Accounts Receivable different from Inventories (another current asset)?
Why are inventories listed after accounts receivable as current assets in the hotel Balance Sheet?
Consider this.
In the case of accounts receivable, the sale is already made.
All that is left to do is to collect the amount of the sale.
However, in the case of inventories, no sale has been made.
So, inventories have first to be sold and then collected after that.
This is what makes inventories less liquid than accounts receivable.
Accounts Receivable are not only more liquid from a sale perspective, they also have another benefit.
There are agencies who for a small commission will be willing to pay the hotel the accounts receivable outstanding now and collect it themselves later on.
These are known as collection agencies.
Defusing the Accounts Receivable Time Bomb
So, how can you defuse the accounts receivable time bomb?
It is by avoiding those three sources of danger we talked about before.
Let me repeat those here for your ready reference.
- Incorrect / delay in invoicing by the hotel
- Ensure that your invoicing is not only correct but also prompt
- Ideally within 48 hours of the first check out of the guest the invoice should be sent to the trafel agent or company
- Normally, credit card companies need not be invoiced separately since the swipe of the card by itself sends the charge on the guest account to them;
- However credit card charges need to be summarized to ensure that all charges have been billed first and collected thereafter
- Delay in collection by the hotel
- Within a few days of the invoice being sent the hotel must follow up with the travel agent or company to ensure that they have received the invoice.
- Credit approved by hotel without due diligence
- The most dangerous of the three situations is bad credit checks
- These can lead to not just delay in payment but often accounts receivable which end up not collectible
- Hotel owners frown upon uncollected accounts receivable which have to be written off to the Profit and Loss Statement and are known as Bad Debts
So, what is the moral of the story?
Well, the moral is: do not fall prey to the Incomplete Sale Syndrome.
Pay attention to the three sources of danger to accounts receivable collection.
In the next blog post which is Part 3 of this 5 part series, we will see how warming signs may come from hotel Inventories.
If you missed Part 1 of this series on the Accrual Land Mine, click here.
How do you defuse the accounts receivable bomb in your hotel?
Comment below.
I will be keen to know your thoughts.
Related Posts
Action Steps You Can Take Right Now
STEP 1
Ensure that your invoicing is not only correct but also prompt
STEP 2
Ideally within 48 hours of the first check out of the guest the invoice should be sent to the trafel agent or company
STEP 3
Within a few days of the invoice being sent the hotel must follow up with the travel agent or company to ensure that they have received the invoice
STEP 4
Ask for a Balance Confirmation once an outstanding reaches 30-60 days
STEP 5
Stop any further credit to the delinquent travel agent or company once outstanding reaches 60-90 days
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