Accounts Receivable - Formula, Importance & Impact

Posted by Harshal on October 26th, 2021

Accounts receivable refers to all the money a business should receive from its customers. Check out Why is Accounts Receivable Management Important?

What is accounts receivable (AR)?

Put simply, accounts receivables are the sales that you’ve made and delivered, but which havent been paid for yet. they’re a record of the fact that you’ve done some work for customer X and that customer X owes you a certain amount of money.

Obviously it’s important to keep a track of who owes you money because these debts need to be paid. For every business that offers some form of credit (payment after receipt of goods or service, for example) they will have some level of accounts receivables a list of outstanding invoices for which someone has not yet paid you.

This varies from accounts payable, which are a list of outstanding invoices that you or your business has not yet paid to other people.

What is the process involved in the Accounts receivable management?

An Account receivable management process involves the following :

• Credit rating i.e the paying ability of the customers shall be reviewed before agreeing to any terms and conditions
• Continuously monitoring any risk of non-payment or delay in receiving the payments
• Customer relations should be maintained and thus to reduce the bad debts
• Addressing the complaints of the customers
• After receiving the payments, the balances in the particular account receivable should be reduced
• Preventing any bad debts of the receivables outstanding during a particular period.

Importance of Accounts Receivable

Impact on day-to-day business operations: Credit control decides the policy to receive payment from customers which is the main source of income for a business and to run its daily activities and expenses. By setting up a credit control policy, the inflow of income would be timelier and that will affect the daily business operations positively.

Better cash flow: A nicely crafted AR policy always improves the cash flow of a business. Generally, AR policy decides the time granted to a customer for credits, so a strict follow up on the same would make the cash flow regular.

Saves time and money: A good credit management policy saves time for business as the cash flow would be done through advance planning. Thus, you will not need to do multiple follow-ups to a client anymore, which would save a lot of time and money for a business.

The benefit of the evolution: With the changing time, the process of accounts receivable management has also been changed with advanced technology and equipment. There are many account receivable automation that can track the credit policy and customers’ payments automatically and saves time for a business.

Better B2B relations: With an AR policy, a business decides the time period granted to its clients based on their credit reports. With that, the business can grant some more time to trustworthy customers and cut down period for risky ones. That will also improve a business’s financial strength as well as build a good B2B relationship with the clients.

Communicate. In a 2013 Transworld Business article, Jason Stine, business development manager for collection services company CRF Solutions, advised regular and prompt communication with clients. Stay on top of transactions; more nonpayment errors develop in the first 60 days after delivery because of insufficient or incomplete customer contact, Stine said.

Create a solid internal process. Determine the process for performing accounts receivable, and stick to it. Pick a day of the week to create, print and mail invoices. Choose another day to print an aged accounts receivable report and contact customers who are beyond their payment term window. As your small business grows, you may need to split these tasks among different people to stay on top of all the accounts.

Confirm receipt of invoices. Many companies have had success in contacting the client a week after the invoice was sent, in order to confirm receipt. Things do get lost in the mail or accidentally deleted in an email inbox. A quick inquiry about receipt of the bill also provides the chance to ask for feedback on the product provided, demonstrating your excellent customer service skills as well.

Extend credit with moderate terms. With today\'s technological advances, companies can receive payment before shipping an order or starting a service. With service-based companies and high-cost goods, however, that may not always be possible. In those cases, have the client apply for a credit line. You will be able to evaluate their payment ability and set a credit limit you\'re comfortable with. It also provides an opportunity to be sure both parties are clear on the terms of payment and what happens if the account goes delinquent.

Document everything. Documentation of accounts receivable helps your bookkeeper with weekly or monthly inputs for financial statements and your accountant at tax time. From first contact, keep notes on the order, conversations and agreed-upon terms. In a worst-case scenario, that documentation will also be important should you have to pursue payment through a collection agency or court.

The funds collected through your accounts-receivable process is the food that fuels the actions of your company. Inconsistent and spotty attention to the task can starve a company\'s growth, while a steady and smooth process results in a well-fed machine capable of achieving all of its goals.

Tips for efficient accounts receivable management

Even though these might look like very common practices, a surprising number of businesses do not follow these basic guidelines. So we have made a list as follows:

1. Do not extend credit to just anyone:

You need to run a credit check via credit management software and verify a customer’s identity in the credit market before agreeing to do business. Most corporate clients have credit accounts of their own and provide all the necessary information before doing business without much ado. It’s okay to deny credit or to ask for payment upfront.

1. Get a Personal Guarantee:

While doing business with a corporate client; it is important to ask for a personal guarantee on your credit agreement. This covenant will confirm the relationship’s authenticity and ensure that the payment is completed from the customer’s end on time.

1. Written Payment Terms for First Order of Business:

Before commencing business with a new customer, it is essential to put all the payments in writing. Inform the client adequately about the total time they will have to pay the due amount, details regarding late fees and interest terms, etc.

1. Send Invoices Promptly:

Often, this point is skipped or not given much importance. But if the customer does not receive the invoice on time, you cannot expect the payments on time. An automated process to streamline sending invoices on time and sending documents more promptly is important.

1. Offer Easy Payment Options to the customers:

Statistics say that customers will typically pay twice as fast if offered easier and convenient payment options. Nowadays, mobile payment has become a very viable payment option with an increasing user base. Platforms like Google pay and PayPal, and other online payment methods, will fetch the business faster payments because of their convenience.

1. Closely Monitor Payments as Received:

Go through the receivable accounts daily to keep a tab on all the payments. Point out the discrepancies and report the same.

1. Plan for Past Dues:

A strategic approach to deal with customers who have due payments and are past the due date. Consider all kinds of things like how many days past the due date will the late fee be charged, how much interest to levy, or how to let the customer know about all information, via call or email and other related things.

1. Consistency with Rules:

You must stick to your plan for managing the accounts receivables. Changing the course of treatment, according to the case, will only harm your business. Taking the steps that you have pre-planned for each situation will simplify your task with a great deal and improve customer adherence.