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:
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.
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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.
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.
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 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.
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.
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.
Though there are fundamental differences between accounts receivable and accounts payable, the two areas do have some similarities. These commonalities include:
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:
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.
Here is a list of 5 common best practices to optimize your AR process:
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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:
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.
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:
Automating your accounts receivable process provides a myriad of benefits to your business, including:
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:
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:
Centime easily integrates into Oracle NetSuite, QuickBooks Online, and QuickBooks Desktop. 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.