Accounts receivable and how it works: Complete 2024 Guide

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Accounts receivable and how it works: Complete 2023 Guide

Accounts receivable (also known as AR) tells you how much of your cash flow is held up in unpaid client invoices. While accounting for receivables tells you how much your clients owe you, accounts payable indicates money you owe to your service providers. There are important differences between the two.

There are many ways you can benefit from and manage your AR, such as efficient documentation, and accounting software that can help you stay on top of your accounting for receivables. This article is for small business owners looking to fully understand their accounts receivable and what is involved.

What are accounts receivable (AR) and how does it impact your business?

Accounting for receivables (or AR) represents the amount of money owed to you from unpaid bills. It is an important measure of the financial security and growth of your business.

Accounts receivable, often known as AR, is a term used for the money a company should receive from its customers after selling products or services. It is the sum of money for which you have issued invoices but have yet to be paid.

Accounts receivable are critical for determining profitability and giving the most accurate measure of a company’s income. It is also classified as an asset since it reflects money entering your business. But it’s important to ensure you have the right measures in place to make your receivables become tangible, by making sure you follow up on client invoices and payments.

Understanding accounts receivable: how it works and why it matters

To calculate profitability, you sum up all of your assets, including accounts receivable, and subtract all of your liabilities (or what you owe to suppliers and vendors). If the figure is positive, the business is profitable. If the figure is negative, you must decide whether to increase assets or reduce liabilities. This can be efficiently done through state-of-the-art accounting software and other AR management procedures by your accountant or accounting firm in Cape Town.

A consistent cash flow is critical for the effective running of any company. Are you getting payments from clients on schedule, and how can your company enhance its accounting for receivables?

How businesses use accounts receivable to manage cash flow

Each unique business will decide how long its customers must pay them. The credit term might be from a few days to many months or more.

Accounting for receivables should be managed consistently and routinely. Each transaction in retail is promptly paid for. But customers in other sectors/industries can apply for a credit line and then place orders against it. With the dispatched product or service, the buyer receives an invoice and payment conditions that are due at a later date.

Payment is critical regardless of your system. Here are five tips to make sure your business stays on top of its accounts receivables:

  1. Maintain open lines of communication with your clientele
  2. Establish a good internal procedure
  3. Confirm invoice receipt
  4. Extend credit with reasonable terms
  5. Keep meticulous records of everything

1. Maintain open lines of communication with your clientele

According to expert advice, we suggest you maintain regular and fast contact with clients – as well as keep track of transactions; as more nonpayment problems occur in the first 60 days following delivery due to poor or incomplete client communication.

2. Establish a good internal procedure

Determine and follow a process for handling accounting for receivables. Choose a weekday to design, print, and mail invoices. Select a different day to print an old AR report and contact clients who have passed their payment-term window.

3. Confirm invoice receipt

A week after issuing an invoice, many businesses have success calling the client to confirm receipt. Things are lost in the mail or are unintentionally erased from an email inbox. A simple inquiry concerning the bill’s receipt allows you to solicit comments on the goods/services given, displaying your great customer service abilities.

4. Extend credit with reasonable terms

Companies may now accept money before dispatching an order or executing a service, thanks to technology improvements. However, with service-based businesses and high-priced commodities, this may not always be possible. In such circumstances, request that the customer apply for a credit line. 

You’ll be able to assess their capacity to pay and set a credit limit that you are comfortable with. It also allows both parties to ensure that they understand the payment conditions and what happens if the account becomes late.

5. Keep meticulous records of everything

Keep records of the order, talks, and agreed-upon terms from the first interaction with a client. In the worst-case situation, that documentation will be useful if you need to seek payment through a collection agency or the courts.

The money received via your AR procedure is the gasoline that keeps your business running. Inattention to the work at hand can suffocate a company’s growth, whereas a seamless process results in a well-fueled machine capable of fulfilling all of its objectives.

The benefits of accounts receivable: how to manage ar effectively

Accounts receivable are a critical component of a company’s basic income. This is considered a current asset, therefore they reflect a company’s liquidity or capacity to meet short-term obligations without generating extra cash flows.

Accounting for receivables is frequently evaluated by using several methods, like the accounts receivable turnover ratio (ART), which indicates the number of times a business has collected its accounts receivable amount within an accounting period. 

AR management guarantees that a company receives money on time. Good accounts receivable management practices may enhance collection operations and help your organization get paid faster. They may also significantly improve your consumers’ experience. Similarly, inadequate practices can stifle organizational growth, at best.

The consequences and dangers of not effectively managing your accounting for receivables

Unintended consequences of a poor accounts receivable management procedure include missed follow-ups on delinquent bills. Outstanding receivables are written off as bad debt. And it affects your business growth and income, at best.

What are examples of accounts receivable? Effective management for business owners

A receivable is established whenever money is due to a company for services given or items delivered, but not yet paid. This can be a sale on shop credit to a consumer after goods or services have been supplied.

Because most business billing is based on accounts receivable, normal invoicing practices are excellent AR examples. If you bill your clients by the hour, invoicing them every hour, day, or even week would get tiresome for both sides. Instead, you’re probably sending out monthly bills and expecting to get paid within 60 days. Your invoice’s value, which reflects a month’s worth of work, is included in your accounts receivable.

An example of accounts receivable is a network service provider that invoices its customers after they have received their service/continue to utilize the service. As it waits for its consumers to pay their accounts, the network company registers outstanding invoices as an account receivable. It all depends on the time given for payment, and the industry your business is in.

Many businesses function by allowing some of their sales to be made on credit. Companies may grant this credit to regular or special clients who receive recurrent bills. Customers may avoid the trouble of physically making payments when each transaction happens. In other circumstances, companies typically provide all of their customers with the option of paying after getting the service.

What are the different classifications of receivables?

Accounts, notes, and other receivables are divided into three types of receivables. As discussed in this article, the most relevant categorization is accounts receivable. Notes receivable are obligations associated with official written letters, whereas other receivables include interest, employee advances, and tax returns.

Difference between accounts receivable and accounts payable: understanding the key distinctions

When comparing accounts payable and accounts receivable, AR indicates the amount of money owed by clients, but accounts payable reflects what you owe your service providers – the total of all your vendors, a third-party company, and supplier bills.

Accounts payable (AP) is what a business owes to suppliers and creditors. This excludes payroll and long-term debt. It does, however, include payments to long-term debt. Assume a fabric supplier (you) delivers a designer an invoice for R1 000 for the fabric the designer bought from them. When the designer receives the invoice, it will be entered into AP because it is money owed to someone else. The R1 000 will be recorded in AR by the fabric supplier (you). This is because they/you will be receiving money from someone else via that invoice.

Accounts payable serves as a reminder to small business owners that what’s in their cash account isn’t always the complete picture. If you have R25 000 in cash but owe R30 000 to suppliers, your cash balance indicates that you are not benefiting. You will be in the red once you have paid your overdue invoices.

To avoid this issue, keep an eye on your accounts payable and pay your bills as soon as you can.

Ways to keep a handle on accounts receivable​

It might be a full-time job to ensure that your clients pay you on time. Accounting firms in Cape Town can assist you in determining if you need to restrict credit or increase collection efforts. They use a unique formula for your receivables collections to assist you in determining which clients are taking longer to pay and how you can tighten your policies for granting credit and collecting more aggressively.

Tools and software for managing accounts receivable

Creating and sending invoices, not to mention confirming their receipt and following up on late invoices, can be time-consuming when organizing and tracking all your receivable and payable accounts. 

Many small businesses outsource their accounting to accounting firms that use the latest technology that provides a user-friendly, highly organized interface for recording transactions and tracking accounting metrics. 

Our Conclusion

If you don’t keep track of accounts receivable, you can forget to bill certain clients, or you might not know if you’ve been paid. This can lead to severe mistakes, such as providing your goods for free, which will ultimately hurt your business.

The longer you wait to produce an invoice, the less likely it is that you will receive prompt payment. Managing your accounts receivable is also a great way to keep track of money when it comes time to file taxes. And because of these facts, accounting for receivables is one of the most important aspects of your business management.

Authoritative Sources:

https://www.educba.com/accounts-receivable-journal-entry/

https://www.lawinsider.com/dictionary/net-book-value-of-accounts-receivable

Information about the authors, publication, and publisher

Picture of Author - Arnaud Brunel

Author - Arnaud Brunel

After a 15 year long career in International Banking and Compliance, Arnaud launched multiple businesses in Cape town. He still heads 2 of these businesses today in the Digital Marketing Industry with Brunel Studios and in the Financial Industry with Thryv.

Picture of Publication & Publisher - Thryv Accountants

Publication & Publisher - Thryv Accountants

Thryv accountants is a private accounting company that focuses on outsourcing of the financial functions of small and medium companies in Cape Town and other regions of South Africa.

The publications on this website are for information purposes only. They are based on our professional opinion.

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