- An outstanding balance refers to money due that has not yet been paid.
- When a customer or debtor fails to settle or settles only part of the payment due, the remainder becomes the outstanding balance.
- Outstanding balances are recorded in various financial documents including accounts receivable and accounts payable.
- Meticulously tracking outstanding balances is key to good fiscal management.
Summary
Key Takeaways
In the world of corporate finance, the term “outstanding balance” refers to all amounts of money that are due, but which haven’t yet been paid and are owed to the creditor by the debtor. Managing outstanding balances is a complex but crucial aspect of good business and can have significant knock-on effects for the financial health of the company.
When it comes to measuring the financial health of a business, one metric which is commonly used is the company’s ability to collect its outstanding payments. If a company is failing to collect its outstanding payments in a timely manner, or if it’s failing to settle its own outstanding debts, this often serves as a warning sign for creditors and investors.
For that reason, it’s critical for any successful business to track and collect or settle their outstanding balances at an appropriate time. The financial future of the company can depend on this.
Types of outstanding balances in business
Outstanding balances can be divided broadly into money owed to the company and money owed by the company.
Outstanding payments arise when customers owe money to a business. When a customer purchases a good or a service from a business, either they pay for it immediately or they’re issued with an invoice. When an invoice is issued, the amount represents their outstanding balance. In other words, the customer owes the business that amount. The total amount owed by customers for goods or services that have been purchased is known as the customer invoice outstanding balance.
In contrast, the term “outstanding debts” refers to the amount of money a business owes to others. This may include payments due to suppliers in the form of accounts payable and payments due on loans taken for capital or operational needs.
Factors contributing to outstanding balances in business
There are several elements in a payment schedule which differ depending on the nature of the transaction and the parties to it. Certain components are common to all payment schedules.
Extending credit to customers by letting them pay for the goods or service they have purchased later can make good business sense but comes with the risk of non-payment or overdue payment. Late payments from customers, for whatever reason, contribute towards outstanding receivables.
This can lead to further costs associated with recovering the debt or renegotiating the payment terms.
Many companies introduce delinquent payment fees or accrued interest to disincentivise customers against overdue payments. In many cases, coupled with good credit management procedures, this will suffice, and customers will settle their outstanding balances within the agreed time limit. In other cases, however, bad faith or the inability to settle the outstanding balance can result in bad debt.
Meticulously tracking and managing outstanding balances is essential to ensure that they do not negatively impact upon the business’s ability to stay afloat or generate new investments and credit.
Importance of managing outstanding balances for businesses
Effective and efficient management of outstanding balances is vitally important for a business’s cash flow and working capital. If resources are tied up in outstanding customer invoices, they cannot be used to invest in new stock or opportunities.
It’s equally important for a business to make sure it clears its own outstanding balances with its own suppliers to maintain good working relationships. A business which pays its debts on time generates trust and a good industry reputation. On-time payments are the foundation of good working relationships with suppliers.
If a business has no outstanding debts but has outstanding payments due to it from its customers, the business is said to have a negative outstanding balance. It owes nothing, and amounts are owed to it.
Failing to track or manage outstanding balances can negatively impact the company’s creditworthiness and access to financing. If a company is seen as being inefficient in chasing up outstanding payments, or lax in settling their own debts, investors and creditors are unlikely to be keen to engage in or maintain financial relationships.
This in turn will hinder the company’s future opportunities for growth and development.
Creating a payment schedule that meets your company’s needs begins with identifying all payment obligations and setting an appropriate payment schedule.
Calculating and monitoring outstanding balances
Meticulously monitoring and managing outstanding balances is crucial to the financial health of a company. Companies need to calculate their balances and ensure payments are made and collected in a timely manner.
The average outstanding balance is a calculation which is made regarding the average amount of money owed to or by a company over a specific period.
The average outstanding balance is calculated by taking the balance at the start and the end of the billing cycle and averaging it over the cycle. It also considers any additional costs such as interest rates and delinquent payment fees, as well as any full or partial repayments that have been made.
If customers’ unpaid invoices begin to build up, the company’s outstanding balance grows. Having too much cash tied up in outstanding balances may prevent the company from settling its own debts, snowballing into further financial difficulties.
The amount of credit initially extended to the customer in the form of delayed payment is referred to as the “principal balance.” To that may be added late fees or interest rates, in which case the outstanding balance consists of the principal balance plus any interest and late fees.
Strategies for managing and reducing outstanding balances
Extending credit to customers and taking advantage of extended credit terms from suppliers can both form part of a good business strategy. However, as is oft repeated, both must be closely and diligently managed if pitfalls are to be avoided.
Some good habits to get into to avoid problems arising from outstanding balances include clear and timely invoicing procedures. Explicit payment terms and timely reminders can avoid confusion and prevent payments from becoming delayed or overlooked.
Negotiating appropriate payment terms with customers and suppliers is also essential to ensure payment dates are aligned and remain achievable.
As well as the disincentives of interest rates and late payment fees, advance payment incentives can encourage customers to settle their outstanding balances before the due date. By offering a percentage off the total amount due if payment is received within a shorter time limit, for example, companies can avoid the headaches associated with chasing past due payments and mounting outstanding balances.
Conclusion
The benefits of extending credit to customers are well known. Customer loyalty can grow, and good working relationships can flourish when outstanding balances are managed meticulously and not allowed to get out of control.
By encouraging early payment and disincentivising late payments from customers, companies can reduce the risks associated with delayed payments, freeing up vital cash flow. This can allow them to settle their own outstanding balances, attract new investment, and engage with new creditors in good faith.
You might also be interested in…
What is credit control and how to implement a credit control process?
What can you do about an overdue invoice?
Late payments: how to collect and avoid them
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