Last updated by
June 10, 2022
The Accounts Receivable process entails tracking and accounting for money owed to a business by customers.
The Accounts Receivable process entails tracking and accounting for money owed to a business by customers. The AR process can simply be defined as credit management.
For a business that sells items on credit, accounts receivable is an asset that needs an effective process and consistent management.
An effective accounts receivable process involves creating a credit framework, efficient and timely invoicing, tracking and follow-up of payments, and proper accounting of all payment receipts.
The accounts receivable process end goal is to improve cash flow in the business and minimize the risk of delinquent payments and bad debts. The right accounts receivable process is key for business survival and profitability.
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Table of contents
Handing over your goods and services on credit is risky. Yet, most supply chains are designed for this type of sale. The key is in the credit framework. A credit framework is the process or steps that establishes a firm foundation to successfully manage credit sales.
These steps should include the following:
The risk of bad debt is real. Businesses need a way of establishing which applicants are safe for credit sales and which are not. In a cash strapped small business this is particularly critical. Checking credit reports and references are key tools in this endeavor.
This is the most critical part of the process as it helps determine who is trustworthy and financially capable of repaying debts. If a customer is unwilling to provide authorization it should be a red flag.
As a company you should establish different credit limits for first time buyers vs. existing customers. Terms should also include payment timeline, early payment discounts, penalties and interest for late payments.
To avoid any compromising issues on the company side, companies should maintain transparency and honesty on all terms and conditions through proper documentation and communication to customers.
Things change, customers change, and the environment changes, so it is vital to have a process in place to continuously review credit policies to ensure they are meeting business needs. Without such a process opens the door to potential loss of valuable working capital.
The invoice is the primary business document used in the accounts receivable process. It serves both the seller and the buyer. It documents the buyer, the product and services rendered, a breakdown of the price, the expected payment terms and the total value of the sale. It is a legal document supporting the business transaction.
The invoicing process and future payment relies on effectively communicating the transaction details and requirements to the buyer. To improve the efficiency and timeliness of invoicing many companies use software. Online software has become very affordable even for small companies. One such software is Xero.com. Software will automate, store and utilize the data for all accounting and follow-up needs.
Consider the below best practices for a smooth and accurate invoicing process:
Even with efficient and timely invoicing, without a follow-up process in place payments will be delayed, and in some cases defaulted on. In most cases it is not because customers are purposely trying to avoid paying, rather it is because they lose the invoice, they are unorganized, and they forget.
Having the following steps in place will increase payments and reduce defaults.
The specific timing and wording of the letter is left up to you to determine based on your understanding of your customer base. The most important thing is consistency. You will find that if you implement these steps and apply them weekly payments will come in quicker, potential problems will be identified sooner, and you will have fewer delinquent accounts.
Ultimately all financial data is critical as it forms the basis of your business decisions, but the lack of accounting for cash receipts causes multiple problems the worst of which is inaccurate cash flow information.
Follow the following steps to ensure your accounts receivable cash receipts are properly recorded.
Picking up mail every day might seem simple, but it is the first step to ensure records are accurate and up to date. Unlike cash payments or credit card payments, check payments most often come in the mail and should not be overlooked. Particularly if you have a PO box that requires a trip to the post office this can be cumbersome but is important.
Regardless of how payments come in, cash, credit cards, or checks should be immediately applied to open invoices to properly reduce the accounts receivable balance. This helps reflect accurate customer account balances in case there are questions on their accounts or depending on when collection notices are sent out.
Another simple step is the deposit. Having cash or checks sitting around have little benefit until they are deposited into your bank account. Checks take several days to clear the bank so the sooner you get them in the bank the sooner the money will be available to use.
Once all the accounts have been updated and the receipts deposited you should ensure the accounts receivable ledger and accounts receivable report is updated. This gives you accurate reports to make decisions. Depending on when you send out collection notices you want to make sure all payments are applied to accounts so you don’t inadvertently send a collection notice to a customer who has paid.