The Ultimate Guide to Accounts Receivable

Everything you need to know about the accounts receivable process, including best practices and common challenges.

Welcome to our comprehensive Accounts Receivable (AR) guide, where you will learn everything you need to know about managing AR for your business. Our team of AR experts crafted this ultimate guide to cover the ins and outs of accounts receivable, including: 

  • The end-to-end AR process 
  • Best practices for efficient AR management
  • Common AR challenges (and how to overcome them)

In addition to these core topics, we also include an FAQ section that answers some of the most common questions asked about AR management. Our goal is to provide you with a thorough understanding of every aspect of AR, so you can approach your accounts receviable management with confidence and clarity.

Thank you for choosing Centime as your guide to mastering AR management. Let's get started!

Defining Accounts Receivable

What are Accounts Receivable?

Accounts receivable are funds that a customer owes to a business after receiving goods or services for which they have not yet paid. Accounts receivable may also refer to goods or services that a customer has purchased on credit. In short, accounts receivable refers to any outstanding balances a business intends to collect from a customer.

Businesses typically aim to collect accounts receivable within a year, but often much sooner. You can think of accounts receivable as a short-term line of credit, where the company expects quick payment for the full amount of the product or service they provided to their customer. 

Accounts Receivable on the Balance Sheet

When it comes to accounting, finance teams record their accounts receivables on their balance sheet as current assets. This is because teams intend to collect their receivables from the customer as a debt within a year. Firms can also use their accounts receivable as collateral to secure a loan. 

Who Uses Accounts Receivable?

Businesses will use accounts receivable any time they offer a product or service for a customer on credit. Firms may use AR to allow customers to utilize a product or service upfront and pay later as a sales tactic for high-ticket items. 

The size of a company often determines who handles its accounts receivable process. Freelancers or sole proprietors may handle AR when first starting out, while larger companies are more likely to have a dedicated AR department.

Accounts Receivable vs. Accounts Payable

Accounts Receivable vs. Accounts Payable: What's the Difference?

Accounts receivable and accounts payable are incredibly different. In fact, they are opposites. As we mentioned, receivables refer to outstanding balances due to a company for providing goods or services on credit. 

In contrast, accounts payable refer to money that one party owes another for goods or services received. In the case of a company, accounts payable may include outstanding bills for supplies, rent, utilities, etc. Payroll is not included in accounts payable.

Accounts Receivable Example 

To further illustrate the concept of accounts receivable, consider a gourmet popcorn shop. They've come to an agreement with a local movie theater to deliver $2,500 worth of popcorn per week. At the end of each month, the popcorn shop sends an invoice to the theater for $10,000 to cover all the popcorn delivered during the month. 

This is where the concept of accounts receivable comes into play. The moment the popcorn shop drops off the popcorn, but before the theater pays for said popcorn, the $10,000 owed to the popcorn shop is considered the popcorn shop's accounts receivable. The money is due to the popcorn shop because they fulfilled their part of the deal but haven't yet been paid for their goods. 

In cases like these, the theater may be expected to pay the $10,000 within 30 days, which is considered to be a short-term credit arrangement. The popcorn shop trusts the theater enough to deliver the popcorn in good faith, trusting they will pay for it in the alloted time. 

Example of Accounts Payable

To illustrate accounts payable, let's continue with the popcorn/theater example. To make their popcorn, the shop must purchase various items like popcorn kernels, flavoring, and packaging. They source their popcorn ingredients and packaging from a one-stop-shop supplier: Supplier X. 

Every month, the popcorn shop places an order with Supplier X for $15,000, and Supplier X delivers the ingredients. Like the theater in the previous example, the popcorn shop receives the supplies without having paid the $15,000 for them yet. Until they pay for those materials, that $15,000 owed is considered the popcorn shop’s accounts payable. 

Note: Not every accounts receivable or accounts payable situation will coincide with this example, but this situation is very common in businesses today. 

The Similarities Between Accounts Receivable and Accounts Payable

Though there are fundamental differences between accounts receivable and accounts payable, the two areas do have some similarities. These commonalities include:  

  • Both affect your cash flow: Accounts receivables signify cash coming in, and accounts payable signify cash going out. 
  • Both have to do with credit transactions: Accounts receivables originate from sales on credit, and accounts payable originate from purchases on credit. 
  • Both carry the element of risk: Accounts receivable is risky given that you may not be able to collect the money from the customer within a specified period. Accounts payable is risky because you may not have the money you owe when the payment due date arrives. 
  • Both involve invoicing: Whether we're talking about accounts receivable or accounts payable, invoices are exchanged between parties.

The Accounts Receivable Process

What Does The Accounts Receivable Process Look Like?

Accounts receivable is not a single, one-touch process. It’s a multi-step workflow that occurs over time and can differ from account to account. That said, most AR cycles involve five common steps: 

1. Onboard your customer: In this first stage, you'll gather and record pertinent customer information. This may include your customer’s billing address and some measure of their creditworthiness. In addition to that, you'll draft a payment plan and share it with your customer. Communicate the payment plan's terms so there won't be any surprises for the customer in the future. 

2. Send out your invoice: Next, you will send your customer an invoice soon after delivering the product or performing the service. An invoice is a document that includes information about the products or services you provided to the customer, along with payment terms that dictate how and when the customer must provide payment. An invoice generally includes the following information: 

  1. Name and address of the customer. 
  2. The business name and address. 
  3. A unique invoice number for the organization. 
  4. The date of the invoice. 
  5. The payment due date. 
  6. A concise description of the products or services sold.
  7. How much everything costs. 
  8. The delivery date of the products or services. 
  9. The total amount due. 

3. Tracking and collecting receivables due: This is where you'll take inventory of receivables due and take steps to collect them. In order to request funds, you might send emails reminding the customer about their upcoming payment due date. You'll also need to follow up if the customer doesn’t pay by their assigned due date. This process of reaching out to customers regarding late payments is often referred to as dunning. In these cases, you can send clients a dunning letter, a past due notice or call the customer directly. 

4. Deductions and exceptions: Sometimes there will be cases where you will need to make deductions from certain accounts to account for returns or pricing issues. In addition, you may need to update your accounts receivable in the case of pricing disputes or product/service quality issues. Say you've provided a product to a customer and then found that a portion of it was unusable - you may offer a price reduction to ensure the customer doesn't feel slighted. Communicate any deductions or exceptions to the client right away. 

5. Cash reconciliation: After you've received a payment from a customer, you'll post it in your accounting system. This step involves locating the invoice and applying the payment to it to show the correct balance. Cash posting is most often done by a dedicated member of a business's finance team since it can be a complex endeavor. 

Accounts Receivable Best Practices

What are Best Practices for Accounts Payable?

Here is a list of 5 common best practices to optimize your AR process: 

1. Use accounts receivable management software.

Accounts receivable requires you to move numbers around and complete potentially complicated transactions. When you tackle things manually, human error becomes a big issue. That's why AR software is so important. It helps to reduce human error, keeping your books cleaner and making your team more efficient. 

Newer AR automation software options now even allow you to customize rules to your specific AR workflow. The average accounts receivable software can assist you from invoice to cash posting and enable you to employ a data-driven-collections strategy. 

2. Evaluate your results on an ongoing basis.

There's no way to know whether or not you're managing accounts receivable effectively unless you track the right metrics, including your DSO, CEI, and more (we'll get into that later in this guide). With ongoing evaluation, you'll have the information necessary to formulate a winning collection strategy. 

3. Have descriptive and targeted policies in place.

When a customer purchases something from you on credit, both of you should have a clear understanding of the relevant credit and collection policies at play. Be sure to write out and update the policies as necessary, ensuring customers are aware at every turn. This goes a long way in reducing confusion and fostering a positive customer service experience. 

4. Send out invoices promptly. 

When it comes to accounts receivable management, time is really of the essence. In fact, how quickly you send out an invoice is one of the most influential determinants of whether or not you'll get paid for it. Sending the invoice immediately after delivering or providing your product or service is always ideal. That way, customers will be less likely to dispute the payment or forget all about their interaction with you. 

5. Keep detailed records. 

Records are extremely important to accounts receivable management. They are necessary for properly tracking outstanding bills and may be required during audits and for tax purposes. But that's not all; records may play a substantial part in the dispute resolution process. So, ensure that your records are always detailed and up to date. 

Benefits of Good Accounts Receivable Management

What are the Benefits of Optimizing your Accounts Receivable Processes?

Managing accounts receivable takes a concerted effort among one or more team members within an organization. This effort is well worth it, given the monumental benefits of good accounts receivable management. 

  • Reduced bad debt. Bad debt refers to money that a business writes off after deeming it uncollectible. If you're taking stock of accounts receivable and working towards recovering those funds, you're more likely to pinpoint customers who aren't good about paying their debts. You can then make efforts to reduce bad debt. A couple of ways you can do that include refusing business to repeat offenders or shortening payment terms.
  • Increased cash flow for your business. Prompt collection of accounts receivable improves cash flow. With cash available, the business can either reinvest the money or hold on to it in the event of an emergency. The money can then go towards paying down business debts.
  • Lower costs. Time is money. The quicker and more efficiently you can recover accounts receivable, the less resources you'll pay in wasted time, effort, and bad debt. The longer it takes to recover outstanding balances, the more time and resources you must invest in AR recovery.
  • Good customer relationships. Managing accounts receivable professionally demonstrates to customers that you are a trustworthy and reliable business. In turn, your customers will feel more comfortable and eager doing business with you over competitors who may not handle accounts receivable responsibly. 

Top Accounts Receivable Metrics and KPIs

Which are the Most Important AR KPIs to Track?

Unlock the full potential of your AR management by implementing Key Performance Indicators (KPIs) to monitor and streamline AR-related tasks and issues. The following 3 core KPIs empower you to track the efficiency of your AR process, identify areas for improvement, and optimize your financial operations.

1. Aging of Receivables/AR Turnover Ratio

This metric lets you know how often you collect your average AR balance in a given period. A low AR turnover ratio indicates that you need to boost your collections efforts or revisit your credit policies and make them stricter. To calculate the AR turnover ratio, divide net credit sales by average accounts receivable. Shoot for a high AR Turnover ratio. 

AR Turnover Ratio = Net Credit Sales/Average Accounts Receivable.

2. Days Sales Outstanding (DSO)

DSO tells you how long it takes for customers to pay you post-invoicing. To calculate this metric, divide your total accounts receivable by your total credit sales and multiply that by 365. The goal with this metric is to get your DSO to be as low as possible. 45 or lower is desirable on a generalized basis. 

DSO= [Total accounts receivable/Total credit sales] x 365. 

3. Collection Effectiveness Index (CEI)

CEI measures how effective your collection efforts are. The formula for this collection performance metric is more complicated. The number you're shooting for is 80% or higher. If you're not yet at that level, there's room for improvement. 

CEI = [Beginning Receivables + Monthly Credit Sales - Total Ending Receivables] / [Beginning Receivables + Monthly Credit Sales - Current Ending Receivables] x 100 

Understanding and leveraging these KPIs can help you make informed, data-driven decisions that ultimately accelerate accounting success. Looking for more AR metrics to measure your success? Our user-friendly AR learning center provides a comprehensive list of AR KPIs, enabling you to take proactive steps towards a more efficient and profitable accounts receivable process. 

Common Accounts Receivable Mistakes

What are the Most Popular AR Mistakes?

We've covered goals and best practices you should work towards as you manage accounts receivable. Now, it's time to get into the most common mistakes that can tank your accounts receivable efforts. By avoiding these five mistakes, you can optimize your AR processes, leading to a healthier cash flow and long-term success.

  1. Trusting untrained professionals to manage AR. AR management can be complex, so entrust it to experienced professionals with the right education and expertise. This ensures accuracy and efficiency in your AR processes.
  2. Not offering incentives for early balance payments. Encourage customers to settle their balances promptly by providing payment incentives. This helps accelerate cash flow and reduces the risk of delayed payments.
  3. Forgetting to track accounts receivable data. Keep a close eye on your AR performance by examining relevant data. Regular analysis helps identify areas for improvement and prevents missed opportunities to enhance your AR management.
  4. Ignoring unpaid balances. Don't rely on a single invoice to ensure payment. Instead, send timely reminders to customers about their outstanding balances. Proactive follow-ups help prevent overdue accounts from turning into bad debt.
  5. Devaluing customer connections. Ignoring or disrespecting customers can lead to delayed payments and damage your reputation. Instead, foster positive relationships with your clients, as they are more likely to pay on time when they feel connected to your business. 

By addressing these common AR mistakes, you can streamline your processes, improve cash flow, and set your business on the path to long-term success. Learn more by reading this article on AR Challenges and how to fix them

Effects of Mismanaging Accounts Receivable

What Happens When Teams Mismanage Accounts Receivable?

In today's fast-paced business world, managing your accounts receivable (AR) effectively is crucial to maintaining a thriving enterprise. Failure to do so can wreak havoc on your cash flow, leading to a domino effect of negative consequences for your small-medium business. These can include, but aren’t limited to: 

  • Less liquidity. When you neglect AR management, your business risks losing liquidity, which can cripple your ability to meet financial obligations and invest in growth opportunities. 
  • Bad debts. This lack of cash flow can snowball into a mounting pile of bad debts, leaving you scrambling to recover funds that may never materialize.
  • Poor customer relationships. Moreover, poorly managed accounts receivable can strain customer relationships, as inconsistent communication and unclear payment expectations may create confusion and frustration. This, in turn, can lead to a tarnished reputation and a potential loss of valuable clients.
  • Inefficiency. Ineffective AR operations also hinder your team's productivity, as they struggle to navigate the complexities of disorganized financial records. This inefficiency not only wastes precious time and resources but also prevents your business from reaching its full potential.

Automating Accounts Receivable

What is the Future of Accounts Receivable?

Embracing accounts receivable (AR) automation is crucial in today's fast-paced business environment, as it addresses the challenges posed by time-consuming manual processes that often plague AR teams. 

With the power of automation at their fingertips, AR teams at small startups and enterprises alike can enhance their operational efficiency, reduce human error, and accelerate cash flow.

What is AR Automation?

AR automation is a process that streamlines and automates some of or all manual tasks associated with the accounts receivable workflow. It optimizes the accounts receivable process, making it more accurate.

AR automation tools can help teams with the following accounts receivable functions: 

  • Creating invoices and sharing them with customers
  • Processing payments 
  • Drafting and sending payment reminders 
  • Reconciling accounts 
  • Tracking and analyzing AR data 

The Benefits of Automating Accounts Receivable

Automating your accounts receivable process provides a myriad of benefits to your business, including: 

  1. Fewer human errors associated with manual data entry. 
  2. Less time and effort required to manage receivables, since the software application will do most of the work for you. 
  3. More cash on hand due to timely collection of customer payments. 
  4. More time to focus on things other than AR. 
  5. Stronger customer relationships.

 Is Accounts Receivable Automation Software Right for You?

From start-ups to established enterprises, accounts receivable automation software offers transformative benefits to upgrade businesses, regardless of size or industry. But when is the right time to automate your AR functions? Here are some tell-tale signs:

  • Your business is growing rapidly and managing accounts receivable processes has become overwhelming.
  • Your AR team only consists of a handful of people, or perhaps it's just you, and you're looking to boost productivity without adding additional headcount.
  • Errors in invoicing, payment processing, or other areas of accounts receivable are causing friction with your customers.
  • Your team wants to leverage automated reports to enhance your accounts receivable management process. 

Managing AR with Centime

If you're on the hunt for an accounts receivable automation solution, consider Centime. It's a premier suite of cash management applications that help you achieve your cash flow goals. The Centime AR Automation application is designed to make sophisticated predictions regarding cash inflows, streamline the collections process, accept payments, and track your AR performance. 

Here are a few ways Centime can transform your accounts receivable management: 

  • Automate payment reminders
  • Accept online ACH and credit card payments
  • Automate cash posting 
  • Track key KPIs, like DSO and CEI 
  • Document customer interactions 
  • Predict late payments 
  • And more! 

Centime easily integrates into Oracle NetSuite, QuickBooks Online, and Sage Intacct. You can use the AR application alone or maximize cash flow by utilizing the whole suite of applications: Cash Flow Forecasting, AP (Accounts Payable) Automation, KPI Tracking and Monitoring, or Centime Credit Line and Credit Card.

If you want to maintain healthy cash flow and let your business flourish, your team needs more than just traditional AR processes to get by. That's why AR automation tools are increasingly essential for finance teams looking to upgrade their operations and eliminate time-consuming, manual tasks. We encourage you to continue educating yourself about AR and leverage AR automation tools to help you stay on top of all your AR responsibilities.


Frequently Asked Questions for Accounts Receivable

What's the difference between AP and AR?

Accounts receivable refers to the money that customers owe a company for services or goods received. On the other hand, accounts payable refers to funds a business owes for supplies, software, contract labor expenses, and more. Accounts payable do not include payroll.

How does a manual AR process look vs. an automated AR workflow?

All AR-related steps are done by hand in manual AR processes, including invoice creation and transmission, payment tracking, overdue bill follow-ups, and more. Not only is this time-consuming for the business, but it often results in costly errors. 

Meanwhile, an automated AR workflow uses software to automate any or all of the tasks mentioned above. Businesses everywhere use AR-focused applications to save valuable time while improving accuracy and productivity. They can then use that extra time to focus more on more strategic initiatives.

What is AR automation?

AR automation refers to using technology to automate tasks in the accounts receivable workflow. These can include: Payment remindersCollectionsPayment processingInvoice generation and transmissionReporting and account tracking

Why should a company use AR automation?

Employing AR automation is a boon for companies that want to properly manage their AR functions. AR automation carries many benefits, including time savings, fewer errors, and increased cash flow from receiving customer payments faster.

How can companies automate customer payment reminders?

Payment reminders are an indispensable part of accounts receivable collections. You could spend a ton of time drafting and sending these yourself, but automating them is almost always the best option. Companies can automate customer payment reminders using software designed to send emails at specified intervals. Often, you'll be able to customize the text in the reminders.

How does AR automation increase collections efficiency?

AR automation drastically increases collections efficiency in several ways by: 
1. Expediting resolution of outstanding debts. 
2. Reducing errors.
3. Automating tracking to give you and your team enhanced visibility into how the collections process is going and inform decision-making. 
4. Minimizes manual labor, freeing up time for your team to focus their valuable time on more strategic projects.

How long does AR automation take?

AR automation project timelines depend greatly on the software you'll be using, the complexity of your AR workflow, and your accounting system. But, on average, it takes a few weeks to fully implement an AR automation tool.