Introduction
Are you a finance professional grappling with the complexity of your company’s Accounts Receivable (AR) process? Or are you a budding entrepreneur trying to fathom the intricacies of the AR cycle? Look no further! We’re about to embark on an insightful journey that will help you understand the AR process and associated best practices with ease. Before we get into the AR process, let’s delve into the basics of AR.
What is “Accounts Receivable”?
The term “Accounts Receivable” sounds daunting, right? Fret not. We are going to make it simple for you. Accounts Receivable is a term used in accounting and is defined as the outstanding invoices or the money due from customers for goods or services delivered by a business. Essentially, Accounts Receivable means the “money customers owe you.” Imagine you run a company that sells coffee beans to cafes. When you deliver the beans, you provide an invoice stipulating that the cafe should pay you within 30 days. During this period, the payment owed by the cafe is considered your Accounts Receivable.
Importance of managing AR efficiently
AR is considered an asset on a company’s balance sheet because it’s money that the company expects to collect. Proper AR management helps ensure a business has enough capital to cover its operational expenses and invest in growth. So, while it’s great to have high sales, your company could face cash flow issues if your customers don’t pay you on time. Hence, managing AR efficiently is critical to the financial health of a business. One way to manage AR efficiently is through automation. Accounts Receivable automation offers significant benefits by streamlining operations and improving accuracy. Growfin is an AR automation software purpose-built for streamlining and automating AR processes across teams collaboratively. Growfin enables the creation of a collection strategy, real-time receivables tracking, collaborative collections, cashflow predictability analysis, and more. Click here to start your free trial of Growfin today!
How does the Accounts Receivable process work?
The Accounts Receivable process involves several steps, such as sales order approval, delivery of goods or services, invoicing, recording of the sale, payment collection, payment application, account reconciliation, and bad debt management. We will look into these steps and the Accounts Receivable best practices one can follow.
Step 1: Sales Order Approval
Picture this: your customer has just ordered a product or service from you. What’s next? Well, it’s time to verify the order. Verifying a sales order is crucial in the Accounts Receivable process cycle to ensure accuracy and prevent future disputes. Here’s how you can verify a sales order:
- Check the Order Details: Confirm that all the particulars of the order are correct. This includes product or service information, quantity, pricing, and specific client requests.
- Review the Customer’s Information: Ensure the customer’s information, e.g., their name, address, and contact details, is accurate. This is particularly important for physical deliveries.
- Verify Customer’s Creditworthiness: If you offer credit terms to your customers, it’s crucial to check their creditworthiness. You can do this by checking their credit history, ensuring they’ve been reliable in making payments in the past.
- Confirm Inventory or Service Availability: Before approving the order, ensure that you can fulfill it. This might involve checking your inventory for product-based businesses or checking your schedule for service-based businesses.
- Ensure Delivery Details are Clear: Confirm the delivery or completion date and any costs associated with delivery or setup.
By meticulously verifying sales orders, you can prevent miscommunications, decrease errors, and improve customer satisfaction. It’s all about setting the right expectations and meeting them consistently.
Step 2: Delivery of Goods or Services
The next step is where you provide the ordered goods or services to your customer. Delivering goods or services to your customers efficiently and effectively is a critical step in the Accounts Receivable (AR) cycle. Here’s how you can do it right:
- Fulfill the Order: Once the sales order is verified and approved, you need to fulfill it. For product-based businesses, this means preparing the ordered goods for delivery. For service-based businesses, it involves assigning the necessary resources or team members to provide the required service.
- Delivery: If you’re selling physical goods, arrange for the ordered products to be shipped to the customer’s designated address. If you’re a service provider, execute the service as agreed upon.
- Documentation: Create and provide the appropriate documentation. This could be a delivery receipt or confirmation for goods, which should include details like product type, quantity, date of delivery, and receiver’s signature. For services, a service completion document is necessary, outlining what was done, when, and by whom.
- Communication: Keep your customer informed throughout the process. If there’s a delay in delivery or a change in schedule, let the customer know as soon as possible. Clear communication helps manage expectations and fosters customer satisfaction.
- Feedback: Get customer feedback once the goods or services have been delivered. This helps you ensure that the customer is satisfied and gives you insights into how to improve your delivery process in the future.
Providing your goods or services efficiently, professionally, and on time is key to maintaining positive customer relationships. And happy customers are more likely to pay their invoices promptly, which keeps your AR cycle running smoothly.
Step 3: Invoicing
Onward to one of the most critical steps – sending the invoice. Here, precision is your best friend. Ensure your invoice details are correct, including product or service descriptions, prices, and payment terms. This is your formal payment request, so double-checking is a must. Here’s how to create and send an invoice effectively:
- Prepare the Invoice: The first step is to prepare an invoice document. Most businesses today use invoicing software that automates much of this process. The invoice should include your business details (name, contact information), customer details, invoice number, date, an itemized list of products or services sold, total amount due, payment terms, and due date.
- Review the Invoice: Double-check the invoice to ensure all details are accurate. A single error can lead to payment delays and create a bad impression on the customer.
- Send the Invoice: Once the invoice is prepared and reviewed, it’s time to send it to the customer. Invoices can be sent via mail, email, or through an electronic invoicing system. Ensure it’s sent to the right contact person to avoid delays.
An invoice is more than just a request for payment. It’s a reflection of your business professionalism. Ensuring it’s clear, accurate, and timely can contribute to maintaining a healthy cash flow and strong customer relationships.
Step 4: Record the Sale
With the invoice dispatched, it’s time for some bookkeeping magic. In this step, you record the invoice as an account receivable in your company’s financial records. Essentially, you’re documenting that someone owes you money. Recording sales transactions is an integral part of the AR process cycle. It helps ensure accuracy in financial reporting and business analysis when done properly. Here’s how you can record a sale:
- Enter the Invoice: Enter the invoice details into your accounting system. Most modern accounting software allows you to input invoice data directly, which can be associated with the appropriate customer account.
- Debit and Credit the Appropriate Accounts: When you make a sale, you need to debit (increase) your Accounts Receivable account and credit (increase) your Sales Revenue account. This reflects that a customer owes you money (increasing your AR), and you’ve earned revenue (increasing your Sales Revenue). Here’s what a journal entry might look like:
Debit: Accounts Receivable Rs 100
Credit: Sales Revenue Rs 100
- Review for Accuracy: Always double-check your entries for accuracy. Mistakes can lead to confusion and inaccuracies in your financial statements, which can misguide business decisions.
- Keep Track of Aging Receivables: Keep a close eye on how long your receivables have been outstanding. An ‘aging receivables’ report can help identify late payments, which can affect cash flow.
Your accounting system is the backbone of your financial management process. A meticulous approach to recording sales ensures that your financial reporting is accurate and meaningful, supporting informed decision-making.
Step 5: Payment Collection
Next, we await our customer’s payment based on the terms outlined in our invoice. But remember, we’re not just sitting around twiddling our thumbs! Stay proactive in gently reminding your customer of the upcoming due date. Your customer service skills shine here, ensuring timely payments while maintaining strong business relationships. Here are the key steps to effective payment collection:
- Set Clear Payment Terms: Make sure your payment terms are clearly stated on your invoices. This includes the due date, acceptable payment methods, and any late payment penalties or early payment discounts.
- Send Timely Reminders: A few days before an invoice is due, send a reminder to the customer. This could be an email or a phone call. Automated invoicing systems often have built-in reminders, saving you time and ensuring consistency.
- Accept Multiple Payment Methods: Make it as easy as possible for your customers to pay. The more payment options you offer, like bank transfers, credit cards, online payment platforms, etc., the quicker you’re likely to receive payment.
- Follow Up on Late Payments: If a payment is late, follow up promptly and professionally. Sometimes, an invoice may have been overlooked. Other times, there might be a dispute to resolve.
- Keep Communication Open: If a customer is struggling to make a payment, maintain open communication to understand their situation. Negotiating a payment plan may be more beneficial rather than demanding the full payment immediately.
- Document Everything: Keep detailed records of all your communication and agreements. This helps maintain clarity and can be useful if a dispute arises.
- Consider Professional Help: If you have persistent trouble with late payments, consider hiring a collection agency or consulting a legal professional.
Effective payment collection is about striking a balance between firmness and understanding. You can maintain a healthy AR cycle and solid customer relationships with clear communication, firm follow-ups, and flexible solutions.
Step 6: Payment Application
Hurray, payment has arrived! It’s time to match the payment with the correct invoice and customer in your accounting system. This may sound mundane, but it’s like finding the key to the treasure chest – essential for accurate record keeping and future reference. Here’s how to apply payments effectively:
- Review the Payment: When a payment arrives, ensure it matches the amount due on the invoice. Also, confirm that the payment is from the correct customer and for the right invoice.
- Enter the Payment in Your Accounting System: Enter the payment into your accounting software. Depending on the system you use, you may need to manually match the payment to the specific invoice it’s intended to cover.
- Adjust the Accounts Receivable Balance: Once the payment is applied, your Accounts Receivable balance for that customer should decrease by the payment amount. This reflects that the customer now owes you less money.
- Issue a Receipt: Send a receipt to your customer acknowledging the payment. This is an important step for maintaining transparency and good customer relationships.
- Review for Accuracy: Regularly review your Accounts Receivable ledger to ensure all payments are applied correctly. If any discrepancies arise, resolve them promptly to maintain accurate financial records.
Remember, payment application is not just about receiving money; it’s about correctly attributing that money to the appropriate customer and invoice. This ensures your financial records are accurate and gives you a clear understanding of your company’s financial health.
Step 7: Account Reconciliation
Account reconciliation is vital in maintaining the accuracy of a company’s financial records. It involves comparing internal financial records against monthly statements issued by external sources, such as banks, credit card companies, or customers, to ensure they match up. Here’s how you can do it:
- Gather Your Records: Collect your internal financial records and the corresponding external statements. You’ll need these documents to perform the reconciliation.
- Compare the Documents: Start by comparing the ending balances of your internal records and external statements. If there’s a match, great! If not, it’s time for some detective work.
- Identify Discrepancies: Look for transactions that appear in one set of records but not the other. These could include deposits in transit (deposits not yet reflected on your bank statement), outstanding checks (checks you’ve written that still need to be cashed), bank fees, or errors in your internal records.
- Make Necessary Adjustments: Once you’ve identified discrepancies, adjust your internal records to reflect the correct information. However, if the discrepancy is due to an error on the bank’s part, you’ll need to contact the bank to have it rectified.
- Document the Reconciliation: Keep a record of each reconciliation process, including the date, the name of the person who performed it, any discrepancies identified, and the adjustments made. This documentation can be crucial for audits and future reconciliations.
- Regularly Repeat the Process: Make account reconciliation a regular part of your accounting process. Doing it monthly is a common practice that helps catch errors promptly and keeps your financial records accurate.
Account reconciliation might seem tedious, but it safeguards against financial errors, fraud, and inaccurate financial reporting. By ensuring your financial records match your external statements, you’re taking a critical step in maintaining the financial health of your business.
Step 8: Bad Debts Management
Lastly, brace yourself for a stormy sea that every business has to navigate – managing bad debts. Despite your best efforts, there will likely be instances when customers fail to pay their invoices, resulting in bad debts. Effectively managing these bad debts can help minimize their impact on your business. Here’s how you can do it:
- Credit Policy: Establish a clear credit policy that outlines the terms and conditions under which you’ll extend credit to customers. This might include credit checks, references, or a trial period of cash-on-delivery terms.
- Proactive Follow-Up: Regularly follow up on overdue payments. Sometimes, a simple reminder is all it takes to get a customer to pay. Other times, you might need to negotiate payment plans or other solutions.
- Aging Accounts Receivable Report: Regularly review your Aging Accounts Receivable report, which shows how long invoices have been outstanding. This can help you spot potential bad debts before they become unmanageable.
- Allowance for Doubtful Accounts: When you identify potential bad debts, create an allowance for doubtful accounts in your financials. This is a contra-asset account that offsets your Accounts Receivable and represents the amount you expect not to collect.
- Write-Off: If you’ve exhausted all attempts to collect an overdue payment and have determined it to be uncollectible, it’s time to write it off as a bad debt. This means you reduce your Accounts Receivable by the uncollectible amount and recognize it as an expense in your income statement.
- Legal Action: In cases of significant unpaid debts, it might be worth considering legal action or hiring a collection agency to recover the debt. However, weigh the potential recovery against the cost and potential customer relationship impact before proceeding.
- Review and Adapt: Regularly review your bad debt management process. What’s working? What isn’t? Adapting your process based on past experiences can help minimize future bad debts.
While bad debts are unfortunate, they’re often a part of doing business. With effective bad debt management, you can minimise their occurrence and impact, helping your business maintain a healthy cash flow and financial stability.
Conclusion
And voilà! We’ve navigated the labyrinth of the Accounts Receivable Process Cycle together. As you become more familiar with these steps, you’ll start to see patterns, making it easier to spot anomalies and manage your AR like a pro.
FAQ
There can be different types of Accounts Receivable based on certain factors. Trade Receivables represent the amounts customers owe for goods sold or services rendered as part of regular business operations. Non-Trade Receivables are receivables that originate outside the regular course of business. Examples could include amounts owed by employees or other associated entities. Notes Receivable is a receivable documented by a formal promissory note, a legal document that provides a written promise to pay a certain amount by a specific date. Accounts Receivable from Related Parties are amounts owed by entities or individuals related to the business, such as parent companies, subsidiaries, or major shareholders. Receivables from Officers or Directors represent amounts owed by the company’s officers or directors. These transactions must be carefully managed and disclosed due to their potential conflict of interest. Each of these types of accounts receivable needs to be managed appropriately and may have different credit terms or collection practices.
Accounts Receivable is categorized as current asset account. It represents the amounts owed to a business by its customers for goods or services sold on credit but not yet paid for. These amounts are expected to be collected within a certain period, typically within a year, hence classified as a current (short-term) asset in the balance sheet.
Accounts Payable and Accounts Receivable are two important components of financial accounting, and they represent opposite aspects of a company’s financial transactions. Accounts Receivable (AR) is money owed to a business by its customers for goods or services that have been delivered or used but not yet paid for. AR is considered an asset on the company’s balance sheet because it represents money that the company is entitled to collect. Accounts Payable (AP) is money a business owes to its suppliers or vendors for goods or services that it has received but not yet paid for. So, when a company purchases goods on credit, the amounts owed to the suppliers are recorded as accounts payable. AP is considered a liability on the company’s balance sheet because it represents the company’s obligation to pay off short-term debt to its creditors or suppliers. In essence, accounts receivable are incoming revenues (assets) that the company expects to receive from its customers, while accounts payable are outgoing expenditures (liabilities) that the company expects to pay to its suppliers. Both are essential to cash flow management in a business.
