A core pillar of business operations, accounts receivable (AR) represents the money customers owe for goods or services delivered on credit.
When managed effectively, AR results in a steady cash flow for businesses, enabling them to meet their expenses, invest in growth opportunities, and maintain optimal financial health.
AR for beginners involves grasping key fundamentals critical to understanding how organizations track and collect payments while building strong customer relationships. Mastering AR practices can prevent cash flow issues and help guarantee long-term business stability.
This in-depth guide explores the concept of accounts receivable, examining its significance, process, and challenges. It also offers practical tips for effective AR management. By the end, readers will be equipped with all the basics and tools they need to confidently navigate AR.
What is accounts receivable?
Put simply, accounts receivable (AR) refers to the money a business owes its customers for goods or services sold with payment terms.
AR is a current asset on the company’s balance sheet, reflecting expected payments that contribute to its cash flow.
Common examples of AR in accounting include unpaid invoices for product sales, subscription services, and completed projects.
The accounts receivable process is integral to an organization’s financial ecosystem. It supports its liquidity and enables it to cover expenses, fund expansion, maintain good customer relations, and remain stable operationally.
Why is accounts receivable important?
Effectively managing accounts receivable is critical for companies of all sizes. Why?
AR benefits include a healthy cash flow, ensuring businesses are paid for the goods and services they’ve delivered on credit. Moreover, AR management directly impacts an organization’s financial reporting, helping it provide an accurate picture of its liquidity and profitability for investors and regulatory entities.
It also supports business growth by allowing timely investments and enabling companies to cover their operational expenses.
Poor AR management, on the other hand, can lead to delayed payments, an increase in bad debts, and cash flow problems, ultimately hindering a company’s ability to scale and remain financially sound.
Accounts receivable vs. accounts payable
Accounts receivable is typically mentioned in the same breath as accounts payable (AP). They’re related, but how do they differ?
In basic terms, AP is the amount of money a company owes to suppliers and vendors for goods or services it has received on credit. The key difference between the two lies in the cash flow direction: AR is an asset representing incoming funds, while AP is a liability representing outgoing payments.
Both AR and AP are core components of an organization’s financial health, with AR focusing on revenue and AP on expenses.
Accounts receivable turnover ratio
The accounts receivable turnover ratio measures how efficiently a company collects its outstanding receivables. It calculates net credit sales by the average accounts receivable balance.
A higher ratio indicates quicker collections and effective credit management, while a lower ratio may suggest cash flow issues, slow payments, or more overdue accounts. Businesses must monitor their AR turnover ratio to assess their liquidity properly, identify collection problems, and make informed decisions about improving their cash flow, AR collection strategies, and business operations.
Accounts receivable process
The accounts receivable process consists of the following steps.
Issuing invoices
The first step in the AR process involves issuing invoices: detailed bills outlining the goods or services provided, their cost, and payment terms. The payment terms specify when the payment is due (for example, net 30 or 60 days).
It’s recommended that companies take measures to ensure that their invoices are clear, accurate, and sent promptly to avoid any payment delays.
Recording entries
Accounting teams document outstanding invoices in financial reports as current assets. On the balance sheet, AR represents money owed by customers, supporting the company’s liquidity. Meanwhile, AR impacts the organization’s operating activities on the cash flow statement, reflecting cash inflows when payments are collected.
Businesses should record accurate and timely transactions to establish financial clarity and effective cash flow management.
Following up on payments
At this point, finance teams should contact customers to remind them of overdue invoices and request payment. The collections process typically starts with friendly reminders but can escalate to more formal communications if the customer delays payment.
Organizations should set clear payment terms, send timely reminders, remain professional, and offer multiple flexible payment options (like credit cards) to encourage prompt settlement and avoid disputes.
Managing overdue payments
Finally, accounting teams should actively monitor and address unpaid invoices beyond their due date. This often includes:
- Sending reminders
- Negotiating payment plans
- Potentially involving collection agencies for persistent non-payment
Staying in regular communication with clients, being flexible, and keeping detailed records of all correspondence can help agents find an effective and mutually agreeable resolution.
Challenges in managing accounts receivable
A variety of AR challenges can affect a company’s cash flow, operational efficiency, and financial health if not adequately addressed. These include the following.
Late payments
Naturally, late payments can disrupt a company’s cash flow, making it difficult to cover operating costs and invest in growth. Delays in receiving payments can lead to liquidity issues and affect the organization’s financial stability.
To mitigate this, businesses should establish and communicate clear payment terms, send prompt reminders, and offer incentives for early payment. Additionally, implementing a structured follow-up process can guarantee that overdue payments are addressed quickly and efficiently.
The right accounts receivable software can also help companies manage late payments by automating invoice generation, tracking due dates, and sending automatic follow-ups to customers.
Bad debts
Bad debts occur when a customer fails to pay an invoice, and the debt is unlikely to be collected. A business typically classifies a debt as bad when it’s been overdue for an extended period (e.g., 90 days or more) and after multiple collection efforts.
Companies can set aside provisions to address bad debts, write off uncollectible amounts, or involve collection agencies. It’s also wise to assess credit risk upfront and clearly state payment terms.
Manual errors and inefficiencies
Accounting teams must also contend with mistakes and inefficiencies during the small business accounts receivable process due to human oversight, data entry mistakes, and inconsistent processes. These issues can lead to inaccurate invoicing, slow payments, and cash flow disruptions.
The good news is that companies can avoid many of these difficulties by implementing AR automation. Specific AR systems will automate invoicing, payment tracking, and follow-ups, reducing human error and improving efficiency.
Automating routine tasks also increases consistency and accuracy, freeing the finance team’s time to focus on strategic activities rather than tedious administrative tasks.
Best practices for managing accounts receivable
Businesses that want to optimize their AR process, receive more timely customer payments, and maintain a healthy cash flow should implement AR best practices.
Establish clear payment terms
One of the best ways a company can reduce confusion and avoid delays is to create and convey clear payment terms. This means specifying due dates, outlining penalties for late payments, offering early payment discounts, and communicating these terms upfront.
Review AR aging reports regularly
Businesses should also regularly review their accounts receivable aging report to identify overdue invoices and potential collection issues. Setting a routine review schedule, prioritizing follow-ups for aging accounts, and using AR tools to analyze trends can improve future credit decisions.
Create customer communication strategies
Developing effective communication strategies can also help organizations collect payments faster. For instance, a company may implement a structured plan for sending friendly reminders and then escalating communications based on the age of overdue payments (remaining professional at all times). This can, in turn, improve cash flow.
Stay compliant
Businesses that continually strive to fully understand AR-related legalities, including tax regulations, payment terms, and credit limits, and remain compliant with accounting standards like GAAP and IFRS are more apt to avoid legal issues.
Some advanced accounts receivable solutions help companies stay current on relevant laws and encourage them to review their compliance procedures regularly.
Provide multiple ways to pay invoices
Companies that offer their customers multiple payment methods, such as credit cards and ACH transfers, often benefit from happier customers and faster payments. Many provide customers with secure, user-friendly platforms for making online payments, clearly communicate their available payment methods, and automate invoice reminders.
In addition, some businesses may offer trusted customers a line of credit, allowing them to make multiple purchases over time and settle the balance periodically.
Automate AR processes
Using tools and software to automate AR processes can help finance teams be more efficient and accurate. For example, invoicing, payment reminders, and reporting can all be automated. Organizations should seek to integrate their AR software with their accounting systems to achieve seamless operations.
Ready to automate your entire accounts receivable process?
Transforming your accounts receivable doesn’t have to be intimidating. A top-tier solution like WisePay enables businesses like yours to control AR for improved cash flow, financial health, and operational efficiency.
Automating AR tasks reduces manual errors and late payments and allows your team to focus on strategic growth. WisePay’s automated invoice sync solution conveniently integrates with ConnectWise PSA, Xero, and QuickBooks Online, supercharging payment collections with automated reminders and real-time payment tracking features. As part of the ConnectWise ecosystem, WisePay understands the unique needs of MSPs and delivers tailored solutions for optimal efficiency.
Ready to optimize your AR process and maximize your company’s potential? Learn how WisePay can automate your entire accounts receivable process today.
