What is Accounts Receivable (AR)? Everything You Need to Know
Taylor Pettis November 29th, 2021
Successful businesses know the importance of running a tight financial ship, and an essential part of that is a strong accounts receivable (AR) process. For organizations that offer extended lines of credit to customers instead of cash-only payments, tracking and managing their accounts receivable is a high-stakes procedure.
But while a robust, highly supported AR process can hugely benefit a business’s bottom line (among other things), it can also present some challenges when handled incorrectly. Here, we’ll take an in-depth look at accounts receivable, the key steps of a successful process, and how automation can help you overcome obstacles for a more efficient operation.
- What Is Accounts Receivable?
- What Is the Accounts Receivable Process?
- What Is Accounts Receivable Aging?
- What Are The Benefits of Accounts Receivable?
- What Is Accounts Receivable Automation?
- Benefits of Accounts Receivable Automation
- What Is Accounts Receivable Management?
- Accounts Receivable: Frequently Asked Questions
What Is Accounts Receivable (AR)?
Accounts receivable (AR) is the payment owed to a business by customers who have purchased their goods or services. In lieu of immediate payment at the time of purchase, accounts receivable acts as a line of credit for clients.
For example, Acme Medical Supplies sells their goods to Memorial Health Center. Then, Acme Medical Supplies invoices them for $10,000 per month for their supplies. That invoice is considered accounts receivable, as Acme extended a line of credit to Memorial instead of collecting their payment up front.
AR acts as recorded assets on a company’s balance sheet, and are considered legal obligations by customers. They thus have an expected payment based on the previously determined terms.
What Is the Accounts Receivable Process?
The accounts receivable process refers to the procedure a business takes to ensure they’re compensated for the goods or services they’ve sold.
While the specifics of an accounts receivable process might differ a bit from one business to the next, there are some key steps that every business should take to make sure nothing falls through the cracks:
1. ESTABLISH CREDIT TERMS FOR NEW CUSTOMERS
Before accepting a new customer, a company must first determine whether or not that customer is able to pay for their goods or services. This helps to avoid issues with non-payment, as the terms, credit limits (based on credit history), and payment deadlines of the credit application received in this step can uncover any potential financial risk.
2. COLLECT THE INVOICE INFORMATION
Next, the company creates a customer invoice by gathering all of the relevant information, such as details on the purchased products or services, the cost of those products or services, and the expected payment deadline.
Each unique invoice is given an invoice number for easy tracking and management, and is either physical (paper) or electronic (email). The format usually depends on customer preference, but some businesses have made the switch to electronic-only invoicing, as they are less expensive, more convenient, and create less waste than the paper alternative.
3. SEND OUT THE INVOICES
Once the invoice is generated, the company then sends it out to the customer—via postal service, email, or both. It’s essential that this step is completed as promptly as possible so that the customer can meet their payment deadline and cash flow isn’t negatively impacted.
Some companies choose to offer incentives for customers who pay early or on time. This helps maintain strong customer relationships and can prevent non-payment and collections.
4. TRACK YOUR INVOICES
Keeping a detailed account of every invoice is paramount to running a healthy business. By tracking invoices, a company can better understand and ameliorate any issues with missed deadlines and send out payment reminders accordingly.
This is a crucial step in the AR cycle, as it guarantees accurate tracking of all payments and can help to determine the liquidity of a business. Without proper tracking, a company risks miscalculating cash flow, which, ultimately, can result in shortages.
What Is Accounts Receivable Aging?
Accounts receivable aging is another important function of the overall AR process. It helps companies note which customers are late on payments (and just how late they are), how often they submit payment past their deadlines, and whether or not it’s worth the risk of maintaining their business.
AR aging is essentially a report that illustrates an organization’s receivables based on the length of time an invoice has been outstanding. The report is developed in a table format so that you can easily understand the financial stability of your current customers.
The report may show, for example, that Customer X is consistently late on their payments, which may mean they’re becoming a credit risk. AR aging allows a company to intervene quickly with collections or to discontinue extending Customer X a line of credit.
What Are The Benefits of Accounts Receivable?
Any business that offers goods or services will benefit from accounts receivable, as it contributes to the company’s ability to cover their own debts and build liquidity. It’s important to note that accounts receivable is considered asset accounts, not revenue.
A company’s receivable turnover ratio measures their ability to collect accounts receivable. It is calculated by taking the sales on credit divided by average accounts receivable and should be fairly consistent to ensure stable growth.
At its root, accounts receivable is essential for keeping track of owed profits, maintaining financial order, and attracting potential investors. Without AR, it’s nearly impossible for a business to determine future revenue, identify risky accounts, and side-step issues in cash flow.
What Is Accounts Receivable Automation?
Because accounts receivable allows companies to precisely track what they’re owed compared to what they’ve provided to customers, it’s essential that the AR process is as error-free as possible. Getting it right can mean the difference between a healthy, scalable business and one that’s riddled with problems in cash flow and profitability.
But companies who still handle their AR with manual processes likely face some obstacles that hinder efficiency—like reconciling physical payments with invoices, tracking late payments, and sending out accurate invoices in a timely manner.
Because the AR process is complex, time-consuming, and sometimes burdensome to already busy teams, businesses have started implementing OCR technology to alleviate the pain of manual data entry. It’s able to transform handwritten or printed text into code for computer analysis, eliminating the need for manual data entry.
1. MORE EFFICIENT WORKFLOW
The right solution can automatically send out invoices, track payments, and more, which saves both time and money.
2. REDUCES EXPENSIVE MISTAKES AND OVERSIGHTS
By tracking payments and simplifying customer communication (through automatic payment reminders, personalized communications, and more), AR automation ensures important activities are never missed. That means fewer invoice errors and late payments, healthier cash flow, and improved customer relationships.
3. REAL-TIME REPORTING
Modern automation tools track every invoice and payment activity in real time, so AR teams can generate accurate reports at the drop of a hat (instead of digging around and manually reconciling information from various spreadsheets).
4. HAPPIER EMPLOYEES
Employee turnover is expensive, but AR automation can take the tedious, repetitive work that leads to unhappy employees out of the equation. And because they don’t have to spend precious hours on manual, burdensome tasks, AR teams can focus on the more impactful initiatives that drive both employee satisfaction and business revenue.
What Is Accounts Receivable Management?
Accounts receivable management is the specific set of processes that support a healthy AR department. It’s a practice that focuses on understanding and collecting a company’s owed payments and is critical for maintaining financial stability and success.
A strong accounts receivable management process requires transparency, efficiency, and powerful tools for support. By implementing a successful AR management process, organizations ensure on-time or early customer payment, solid working relationships, and a real-time understanding of profitability and liquidity.
Accounts Receivable: Frequently Asked Questions
Accounts receivable has many moving parts, and is thus a complex topic to grasp. Here, we’ll dive into some frequently asked questions to help you further understand AR as it relates to your overall business:
What Is the Difference Between Accounts Receivable (AR) and Accounts Payable (AP)?
Accounts payable is, simply put, the antithesis of accounts receivable. Accounts payable refers to the money your company owes other businesses. Where AR is considered a recording of assets, accounts payable is known as a liability account.
Is Accounts Receivable Revenue?
Accounts receivable is considered asset accounts, not revenue, as it’s converted into cash in a set period of time. Accounts receivable includes all unpaid invoices, where revenue refers to the amount recorded for the sale of goods or services. Thus, the AR balance is generally larger than the reported revenue found on a company’s income statement.
Where Can I Find Accounts Receivable?
Accounts receivable is noted on your balance sheet or chart of accounts.
What If My Clients Don’t Pay?
Even with a strong AR process, there’s always a chance that clients won’t pay their bills. Luckily, there are many steps you can take to help make the collections process a quick one.
When clients don’t pay, it’s categorized as a bad debt expense. Companies estimate “bad debts” for the fiscal year in order to keep their books balanced and ensure they’re not overestimating their AR on their financial statements. This process is called allowance for uncollectible accounts.
Take Your Accounts Receivable to the Next Level
As businesses look to maintain sustainability and scalability, they’re realizing the impact of accounts receivable on their overall growth and stability. Many now understand that the outdated AR methods of the past (e.g. manually sending and receiving invoices, calculating accounts receivable, tracking payments, and more) have led to workflow inefficiencies and inaccurate reporting.
MHC NorthStar offers state-of-the-art software that automates AR processes—from invoice generation and delivery to personalized customer communications—to streamline workflows and put more time back in employees’ days. Learn more about how MHC NorthStar’s accounts receivable automation can make your AR process a breeze.