Accounts receivable is a critical part of any business’s financial management, representing the money that a business is owed by its customers for products or services that have been provided but have yet to be paid for. In this article, we’ll explore accounts receivable, how it is managed, and why it is important for businesses of all sizes.
TABLE OF CONTENTS
What are accounts receivable?
Accounts receivable (AR or A/R) is a term used in accounting to refer to the money a business or organisation owes its customers or clients for products or services sold on credit. It represents the amount of money that a business expects to receive from its customers in the future.
Accounts receivable are recorded as an asset on a business’s balance sheet, representing a claim against the business’ customers for payment. Managing accounts receivable is an important part of a company’s financial management. It involves tracking and collecting customer payments promptly and efficiently to ensure the company has the adequate cash flow to meet its operational and financial obligations.
How accounts receivable work?
To understand better how accounts receivable move within an organisation and its importance for the business, we must look at the accounts receivable process, learn its key differences from accounts payable – and how AR and AP are connected for a healthy cash flow.
The Accounts receivable process
The accounts receivable process is a business’s set of steps to manage its accounts receivable and collect payments from its customers. Also called the Order-to-Cash process, your accounts receivable process in your business might typically include the following steps:
1. Processing credit applications
To offer goods on credit, a company needs to develop a credit application process and assess the applicant’s creditworthiness. They must also establish terms and conditions that comply with Federal laws on credit, and consider factors such as interest rates and collection time frames. Terms may differ for large and small firms due to cash flow and capital considerations. Collecting the debt in a timely manner is crucial for the company’s cash flow and capital needs.
2. Generating an invoice
When a customer purchases a product or service on credit, the business generates an invoice that lists the transaction details, including the amount owed and the payment terms.
3. Recording the invoice
The business records the invoice in its accounting system and updates the accounts receivable balance to reflect the amount the customer owes your business. You can automatically process this task when you integrate your accounting system or ERP with accounts receivable software.
4. Sending the invoice to the customer
The business sends the invoice to the customer, along with any other required documentation.
5. Following up with the customer
If the invoice becomes overdue, the business follows up with the customer to remind them of the outstanding balance and requests payment. Leveraging automation as part of your communications workflow in following-up payments is crucial. This allows you to customise send schedules and follow-ups and automatically send invoice payment reminders, saving your team time chasing payments.
6. Recording the payment
When the customer makes a payment, the business records the payment in its accounting system and updates the accounts receivable balance to reflect the reduced amount owed by the customer.
7. Reconciling the accounts
The business periodically reconciles its accounts receivable balance with its general ledger to ensure that the amounts recorded in its accounting system are accurate and current. Modern accounts receivable software can automatically reconcile invoices upon receiving payments and sync with your accounting system to ensure one source of truth for your accounting data.
8. Reporting
The business generates reports to track its accounts receivable balance, outstanding invoices, and payment history. These reports help the business monitor its cash flow and identify potential issues with its accounts receivable process.
Implementing accounts receivable software can help you establish a well-designed accounts receivable process. By automating your process, you can ensure your business collects customer payments promptly and efficiently, which is essential for maintaining healthy cash flow and financial stability.
Accounts receivable vs accounts payable
Accounts receivable (AR or A/R) is the money a business owes its customers for products or services sold on credit. It represents a current asset on the business’s balance sheet, an amount it expects to receive in the future.
On the other hand, accounts payable (AP) refers to the money a business owes to its suppliers or vendors for products or services it purchases on credit. It represents a current liability on the business’s balance sheet, an amount it expects to pay in the future.
The key difference between accounts receivable and accounts payable is that accounts receivable represents money owed to the business by its customers, while accounts payable represents money owed by the business to its suppliers or vendors. Accounts receivable is an asset for the business, while accounts payable is a liability.
Why are accounts receivable important for businesses?
Accounts receivable are important for businesses for several reasons:
Accounts receivable help ensure a healthy cashflow
Accounts receivable are a source of cash for businesses. By collecting money owed to them, businesses can maintain a healthy cash flow and use that cash to pay bills, invest in new projects, and grow their business.
Accounts receivable is critical to managing working capital
Accounts receivable are also an important part of a business’s working capital. Working capital is a business’s money available to fund its day-to-day operations. Accounts receivable represent the money a business expects to receive in the near future and can be used to fund current operations.
How to manage working capital and improve cashflow in your business
Accounts receivable indicates a business’ creditworthiness
Accounts receivable can also indicate a business’s creditworthiness. A business with a high level of accounts receivable shows that it has a healthy customer base and can generate sales. This can make the business more attractive to investors and lenders.
Accounts receivable help establish good customer relationships
Accounts receivable can also be a way for businesses to build and maintain good customer relationships. Businesses can foster goodwill and loyalty by providing customers with flexible payment terms and responding to their payment inquiries.
Make Your Working Capital Work for You: Ways to Optimise Your Accounts Receivable
What does an accounts receivable on a balance sheet indicate?
Accounts receivable are part of the Current Assets in the balance sheet and are an important component of a company’s working capital.
When analysing a company’s balance sheet, the level of accounts receivable can provide insight into the company’s sales and collection practices.
A high level of accounts receivable may indicate that a company is selling a significant amount of products or services on credit, which can be a positive sign for sales growth. However, a high level of accounts receivable may also indicate that a company is having difficulty collecting payments from its customers, which can be a concern for cash flow and financial stability.
Overall, the accounts receivable on a balance sheet are an important indicator of a company’s financial health and ability to collect payment for its sales.
To better understand accounts receivables and the effectiveness of your collections, you can compute the accounts receivable ratio.
What is the accounts receivable turnover ratio?
The accounts receivable turnover ratio is a financial ratio that measures a company’s effectiveness in collecting its accounts receivable.
The formula for calculating the accounts receivable turnover ratio is:
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
Where Net Credit Sales is the total credit sales made during a period, and Average Accounts Receivable is the average amount of accounts receivable during that period.
The accounts receivable turnover ratio shows how often a company can convert its accounts receivable into cash in a given period. A higher ratio indicates that a company can collect its accounts receivable quickly, which is generally positive. Conversely, a lower ratio suggests challenges in collecting payments on time.
Accounts receivable turnover ratio: How to interpret and improve it
Best practices for managing accounts receivable
Effective management of accounts receivable is essential for maintaining a healthy cash flow in a business. Here are some best practices for managing accounts receivable:
1. Establish clear credit policies
Set up clear credit policies that define your payment terms, credit limits, and the consequences for late or non-payment. An online credit application system can help ensure you don’t miss these details during onboarding.
2. Perform credit checks
Before extending credit to customers, perform a credit check to assess their creditworthiness and ability to pay. Leverage business credit score data to help you make informed decisions on approving credit applications and gain insights on your customers’ credit and payment behaviour.
How an enhanced credit application process can protect your business from bad debts
3. Invoice promptly and accurately
Ensure that you invoice promptly and accurately. Late or inaccurate invoices can cause delays in payment and lead to disputes.
4. Follow-up on overdue payments
Regularly follow up on overdue payments. Send reminders, make phone calls, and escalate collection efforts to a debt collection service if necessary.
Related blog post: https://ezycollect.io/blog/overdue-invoices-templates-for-email-and-sms-reminders/
5. Offer multiple payment options
Offer multiple payment options to your customers, such as credit cards, online payments or auto-debit payments. Providing convenient options for your customers to makes it easier for customers to pay you, leading to less late payments and a better customer experience.
6. Monitor receivables
Monitor your accounts receivable regularly and track the aging of each account to identify potential delinquencies. You can use an accounts receivable template to manually track receivables on a spreadsheet. Implementing accounts receivable software to automatically monitor and update your receivables and sync with your accounting system can make this important task easier for your team.
Managing AR: Free Accounts Receivable template vs. AR Automation software
7. Establish a collection policy
Establish a clear and consistent collection policy outlining the steps to collect overdue payments. A collection policy will guide your team on the next steps to take when dealing with overdue payments and allow your team to maintain a consistent approach on collections.
8. Analyse accounts receivable turnover ratio
Analyze your accounts receivable turnover ratio regularly to identify trends in your order to cash cycle and highlight areas for improvement in your collections process.
How to improve your accounts receivable process
Managing your accounts receivable effectively can help you maintain a steady cash flow and reduce the risk of bad debts. Your business can improve its accounts receivable process in several ways:
1. Automate invoicing
Automation can speed up the invoicing process and allow you to send out invoices immediately after a sale is made. This reduces customers’ time to receive their invoices and can help ensure that payments are made on time. Automation also helps reduce errors that can cause disputes and further delay payments.
2. Automate follow-ups and payment reminders
Automated accounts receivable software can send payment reminders to customers automatically, helping you save time collecting payments and reducing the risk of missed or late payments.
3. Offer early payment discounts or credit term extensions
Offering discounts to customers who pay early can effectively encourage timely payment. Another viable option is to offer credit term extensions for customers who sign up to pay via direct debit.
4. Implement a payment gateway
Implementing a payment gateway that allows customers to pay from your e-commerce store can make it easier for them to make payments, reducing payment delays. An integration with your accounts receivable software ensures payment data is centralised in one location for all your customers’ invoices.
New payment gateway: ezyCollect Payments x WooCommerce integration
5. Conduct regular credit checks
Regularly checking the creditworthiness of your customers can help you identify potential delinquencies and reduce the risk of non-payment. Leverage business credit scores as part of your credit monitoring process to make informed decisions in collecting payments.
6. Monitor acccounts receivable aging
Monitoring your accounts receivable aging regularly can help you identify and address overdue accounts. Ensure you can view your aging receivables in a dashboard in your accounting system to monitor accounts that need attention easily.
7. Personalise customer communication
Automated systems can send personalised follow-up messages to customers, which can help to build stronger customer relationships and encourage timely payments. Regularly communicating with your creditors helps build a good working relationship and keeps them updated on any changes in your business and vice versa.
8. Consider debt collection services
Consider debt collection services as an integral part of your accounts receivable process. Before writing off aged receivables as bad debts, a debt collection service can help you strategise the next steps to take to collect debts. This can help you recover aged receivables, improve cash flow and reduce the burden of collection efforts.
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Conclusion
In summary, accounts receivable is important for businesses because it helps maintain cash flow, provides working capital, indicates creditworthiness, and helps build and maintain customer relationships.
It is also important to manage accounts receivable effectively to ensure that the company is paid promptly and does not have excessive amounts of cash tied up in unpaid invoices.
AR automation software can help you manage your accounts receivable process efficiently, so you can focus on what you do best – growing your business. Speak with one of our AR experts today to learn about options for your business.
Accounts receivable FAQs
Q- What can I do to make people pay faster?
Implementing automation in your accounts receivable process is the easiest way to get paid faster. An accounts receivable software lets you automate sending payment reminders via email or SMS and allows you to offer online payments with multiple payment options to make it easier for your customers to pay you.
Q – What is an Accounts Receivable Aging Report?
An accounts receivable aging report is a financial report that summarises the outstanding customer invoices and payments in your business. The purpose of the accounts receivable aging report is to help your business identify overdue accounts and allow you to take action to collect outstanding balances. The report typically lists all customer accounts with balances due and categorises them according to the time they have been outstanding.
Q – Is accounts receivable an asset?
Yes, accounts receivable are considered an asset on a company’s balance sheet. Accounts receivable represents the money a company owes its customers for products or services that have been provided but have not been paid for. It is a type of current asset because it is expected to be converted into cash within one year from the date of the balance sheet.
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