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Every business relies on getting paid for their products and services, but waiting for customer payments to roll in can be a nerve-wracking experience. Taking control of accounts receivable doesn't need to be a painful process. With the right strategies, you'll be a receivables collection master quickly. 

Read on as we uncover the secrets to getting a grip on your accounts receivable. 

What is accounts receivable (AR)? 

Accounts receivable, also known as trade receivables, customer receivables or AR, is one of the most important assets for many businesses. 

The definition of accounts receivable is that it is the money due to a business for work performed, products sold, or bills generated before receiving payment. In other words, it's the money customers owe on their outstanding balances and invoices. As customers purchase on credit and payment is not immediately received, the amounts owed get booked as accounts receivable until collected. Properly managing accounts receivable is critical for business cash flow and continued operations.

Accounts receivable vs. accounts payable: key differences

Here are some of the critical differences between accounts receivable and accounts payable:

Accounts receivable

  • Account receivable refers to money owed to a business by its customers or clients. It represents services or goods that have been delivered or used but have yet to be paid for by the customers.
  • Accounts receivable are shown as an asset on the company's balance sheet since the company is owed money and the company has the right to these assets. Accounts payable are shown as a current liability on the balance sheet since the company owes money to others.
  • Accounts receivable increase when sales are made on credit terms and decrease when customers make payments. Accounts payable increase when suppliers deliver goods or services and reduce when the company makes payments to suppliers.

Accounts payable

  • Accounts payable refers to money a business owes its suppliers or vendors. It represents goods or services received from suppliers, but payment has yet to be made for them by the company.
  • Accounts receivable usually involve extending credit terms to customers, so the company "gives" money by allowing delayed payment. Accounts payable usually have predefined payment terms set by suppliers, so the company "receives" credit from vendors.
  • Managing accounts receivable involves credit analysis of customers, determining credit limits, and collecting outstanding payments on time. Managing accounts payable involves verifying supplier invoices and ensuring payments are made on agreed-upon due dates to receive discounts, if any.

Relationship between accounts payable and accounts receivable

Accounts payable and accounts receivable are inherently linked functions within a company's financial accounting system. Accounts payable records a company's short-term debts to suppliers and vendors for items purchased on credit. On the other hand, accounts receivable represent the short-term debts owed to the company by its customers who buy goods or services but do not pay immediately. 

Importance of managing accounts receivable

Effective accounts receivable management practices allow a business to track what customers owe, follow up on outstanding invoices, and ensure cash keeps flowing promptly. Pay deadlines can positively impact cash flow.

Some key benefits of accounts receivable management include:

  • Reducing the risk of uncollected debts and bad debts stresses cash flow and profits. Proper follow-up helps collect payment before accounts become uncollectible.
  • Monitoring payment patterns and identifying customers that consistently pay late helps prevent future cash flow problems. This allows for better financial planning and forecasting.
  • Maintaining positive customer relationships by promptly addressing any billing questions or issues. This minimizes misunderstandings that could jeopardize future sales.

Strong accounts receivable practices are crucial because they help ensure swift invoice-to-cash conversion, which is vital for meeting financial obligations on time. The importance of accounts receivable management must be balanced for financial health and stability.

How does an accounts receivable process work?

Efficiently tracking what customers owe and collecting payments is vital to maintaining a steady cash flow.

The typical accounts receivable process follows these steps:

  1. Agree on contracts and establish payment terms and accounts receivable policy. Negotiate terms of services and products with customers and indicate the payment terms in advance. The usual payment term is net 30 or n30. An account receivable policy is also needed to guide when accounts will be considered delinquent and when bad debt losses and write-offs will be recognized. Most companies recognize bad debts after 90 days of delinquencies.
  2. Invoice customers after a sale or service is provided. Record the invoice in the accounts receivable system or ledger. This establishes the amount owed by the customer.
  3. Monitor payments and due dates. Most customers are given 30 days to pay, so accounts receivable staff track what is owed and follow up with pending payments. This can be automated through your billing process.
  4. Apply payments to outstanding invoices once received. Payments are recorded to clear the balance on paid invoices. Partial payments are also applied.
  5. Manage collections of overdue invoices. For unpaid invoices past due, accounts receivable will begin collection calls and letters to request payment. Additional interest or fees may apply
  6. Record resolved invoices once payment is received. Invoices are closed out of accounts receivable once fully paid or deemed uncollectible.

Calculating accounts receivable turnover shows how quickly customers pay and how efficiently receivables are managed. It is the ratio of net credit sales to average accounts receivable. A lower turnover means it takes longer to collect payment from customers.

Stay tuned for our upcoming article, where we will discuss how the accounts receivable process works in a more detailed and in-depth manner. 

Examples of accounts receivable

For example, a law firm completes $10,000 worth of legal work for a new client in September. Instead of collecting the full amount immediately, the firm emails an invoice with net 30 payment terms. On October 1st, the $10,000 owed by the client appears as an account receivable asset on the firm's balance sheet and remains there until the payment has been made. The journal entries made are:

  • 10/1/2022 - Debit: Account receivable $10,000
  • Credit: Legal revenue $10,000

This reflects the value of the services rendered for which payment has yet to be received. Until the client pays by October 30th, the account receivable will remain on the books until the cash is collected. The journal entries made are:

  • 10/31/2022 - Debit: Cash $10,000
  • Credit: Account receivable $10,000

Best practices for accounts receivable management

Managing accounts receivable effectively is crucial in keeping cash flowing and your business finances healthy. Here are some tips you can implement to optimize your accounts receivable process:

  • Create a clear and concise account receivable policy: Ensure payment terms are communicated in all customer agreements and ensure that the accounting team knows when and how to recognize delinquencies, bad debt provisions, and losses.
  • Send clear and timely invoices: Ensure invoices are sent promptly after a sale and include all relevant order and payment details.
  • Offer payment options: Give customers flexibility by accepting various payment methods like credit cards, checks, and electronic fund transfer (EFT) to make paying convenient.
  • Follow up on outstanding invoices: Have a standardized process to contact customers if payment is late and offers payment plan options if needed.
  • Analyze customer payment patterns: Understand when different customers typically pay to manage cash flow better, identify late payments and determine if certain past due account receivable should be written off.
  • Automate billing and collection reminders: Use accounting software to schedule automatic reminders and notices at predetermined intervals to streamline follow-ups.
  • Record customer payment agreements: Document approved payment extensions or plans to track commitments and ensure payments are received as expected.

Streamlining accounts receivable with Ramp

Managing accounts receivable can be time-consuming without the right tools. Spreadsheets and manual data entry often lead to errors and delays in payment collections. 

Ramp is among the best accounting automation software that helps organizations streamline their accounts receivable process. We integrate with your accounting system to automatically sync invoices and payments. 

Automated payment reminders and receipts help accelerate payment times. Our invoice automation allows you to create and send invoices electronically quickly. Try Ramp’s accounting automation software today and see how it can help your team get paid faster. 

Try Ramp for free
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Senior Controller, Ramp
Born and raised in Haiti, Edwine has lived in Canada, France, Grand Cayman, and currently resides in Boston with her family. She is a CPA and has had many leadership roles at EY, PwC, and Circle. She joined Ramp in March 2021 as our first controller.
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