Accounts receivable as the backbone of financial stability

The goods or services are delivered, the invoice is out, and the countdown begins before payment is received for a job well done. This expected payment is what finance organizations call “accounts receivable” (AR).

Take, for example, a manufacturer that delivers US$10,000 worth of products to a customer with a 30-day payment term. The company’s finance department records this invoice on its balance sheet as an AR. Once the customer pays the invoice, the company’s cash account increases and the AR is reduced to reflect successful debt collection.

While AR helps businesses maintain the cash flow necessary to cover expenses, invest in growth, and sustain operations, many finance organizations struggle to stay on top of their collections. The longer the AR goes unpaid, the more difficult it is to maintain day-to-day operations. Moreover, long-term financial health may deteriorate.

When it’s clear that a customer won’t pay the invoice, finance organizations write the charge off as a bad debt expense. Alternatively, they could sell the outstanding debt to a third-party collector for a fraction of its original value—a process known as accounts receivable discounting.

Neither option is ideal, as both significantly impact a company’s financial health. Ultimately, finance leaders aim to ensure timely collection to avoid these outcomes, maintaining a healthy cash flow and minimizing financial losses.

Proactive AR management keeps business finances stable by avoiding the pitfalls of unpaid invoices. This involves establishing credit policies, tracking outstanding invoices, and ensuring timely collection. Companies also use aging schedules to monitor the status of receivables, categorizing them based on how long they’ve been outstanding.

The accounts receivable cycle

Representing the amounts that customers owe to the company, accounts receivable (AR) arises when a company defers payment of a transacted sale until final delivery and issues an invoice specifying the amount owed and payment terms. Then, the company records the amount as a current asset on the balance sheet, indicating the expectation that it will materialize into cash within a short period (typically one year).

Companies list AR under their current assets, making it a critical metric of short-term financial health. In accrual accounting, companies recognize revenue when they perform the service or deliver the product, even if they aren’t paid immediately. This creates a receivable account, reflecting the company’s claim to payment in the future.

Several financial KPIs help assess the efficiency of AR management. For example, days sales outstanding (DSO) measures the average time it takes to collect receivables. The accounts receivable turnover ratio is another common metric, indicating how frequently a company collects its average receivables during a specific period. The lower the DSO and the higher the turnover ratio, the more efficiently a company manages its AR.

Proper management of AR is critical to a company’s working capital and liquidity. It allows the business to gain sufficient cash flow to meet financial commitments while strengthening customer relationships. Meanwhile, offering credit terms adds convenience to the buying experience, increases customer satisfaction and loyalty, and boosts current and future sales revenue.

Related accounts receivable terms

Familiarity with key concepts associated with accounts receivable (AR) allows for more effective financial oversight, reducing the risk of cash shortages and improving the company’s operational stability.

Accounts receivable aging schedule

An accounts receivable aging schedule, often called an AR aging schedule, is a specific type of accounts receivable report. It presents a categorized list of unpaid customer invoices and their respective due dates—typically separated into time intervals such as:

• 0–30 days past due
• 31–60 days past due
• 61–90 days past due
• Over 90 days past due

As a finance tool, the report helps companies evaluate and manage their outstanding customer invoices while identifying potential cash flow issues and understanding the financial health of their customers.

Accounts receivable turnover ratio

The accounts receivable turnover ratio measures how often a company’s receivables are collected during a specific period, usually a year.

On average, an AR turnover ratio between five and 10 is reasonable for a business. However, a higher AR turnover ratio indicates a company is more efficient at collecting receivables than its peers, and that its customers are paying their debts quickly. Conversely, a lower ratio may indicate inefficiencies in the collection process or issues with customers’ ability to pay on time.

Accounts receivable report

An accounts receivable report details a company’s outstanding invoices and customer payments. This report includes information on amounts owed, payments received, and key metrics such as days sales outstanding (DSO) to help businesses manage their cash flow and assess financial performance.

AP ledger

AP ledger is a detailed financial record maintained by a company that tracks accounts payable, which is the amount owed to suppliers and creditors. It’s part of a company’s accounting system and provides a comprehensive view of all outstanding liabilities that arise from unpaid supplier invoices, purchase orders, and other financial obligations.

Collections

Collections is the process of pursuing and obtaining payment on outstanding invoices and debts owed to the business by its customers. Effective collections are essential for maintaining healthy cash flow and ensuring the company meets its financial obligations.

Credit terms

Credit terms, also known as payment terms, are the conditions under which a seller provides products or services that the buyer pays for later. These terms specify the amount of time the buyer has to pay the invoice and may also include any discounts available for early payment.

Day sales outstanding (DSO)

DSO is a financial metric that measures the average number of days it takes for a company to collect payment from its customers after a sale is finalized. By monitoring and analyzing DSO, companies proactively improve their credit policies, enhance collections processes, and strengthen their financial health.

Debt

Debt is an obligation that requires the borrower to pay money or other agreed-on value to the lender or creditor. It typically arises when an individual, business, or government borrows funds under the agreement that the borrowed amount (or principal) will be repaid at a future date, often with interest.

The term “good debt” refers to investments that drive growth and expansion without directly compromising financial health.

A debt is considered “bad” when the outstanding balance is uncollectible due to bankruptcy, cash-flow difficulties, or negligence.

Debtor

A debtor is an individual, organization, or entity that owes the creditor money or some other form of debt. Whether the debt is personal, corporate, or public, the debtor must repay the borrowed amount, often with interest, by an agreed-on date or according to a pre-arranged repayment schedule.

Double entry

Double-entry accounting is a bookkeeping system that balances the sum of liabilities and equity with the total value of business assets. This method requires every financial transaction to be recorded in at least two different accounts: a debit in one account and a corresponding credit in another account. The total debits must always equal the total credits for each transaction.

Factoring

Factoring is a financial transaction in which a business sells its AR (invoices) to a third party—known as a factor or factoring company—at a discount to improve cash flow, manage liquidity, and outsource the collections process. This process provides the business with immediate cash flow, rather than waiting for the payment terms specified on the invoices.

Invoicing

Invoicing is the process of generating and sending a detailed statement to customers to request payment for products or services provided. The invoice is an official document outlining the terms of the sale, the amount due, and the expected payment date. Each invoice is recorded as an AR entry in the seller’s balance sheet—whether outstanding or unpaid.

Liquidity

Liquidity measures the ability to quickly convert an asset into cash without significantly affecting the market price. It indicates the financial health of individual assets and entire organizations, reflecting the ability to meet short-term obligations and operate effectively without unnecessary financial strain.

Net accounts receivable

Net accounts receivable is the amount of money a company expects to collect from its customers after deducting allowances for doubtful accounts, returns, and discounts. It provides a more accurate estimate of the actual cash inflows from receivables, reflecting the potential adjustments for accounts that may not be fully collectible.

Other receivables

Other receivables refer to amounts owed to a company unrelated to regular sales transactions. Categorized separately from standard AR, these receivables include interest receivables, employee advances, and tax refunds. Monitoring other receivables under current assets on the balance sheet helps track various financial relationships and outstanding obligations beyond typical sales activities.

Receipts

Receipts are the actual payments received from customers for goods or services provided on credit. These payments reduce the outstanding balance of the AR on the company’s books.

Receivables balance

A receivables balance is the total amount of money customers owe to a business for goods or services provided on credit.

Receivables write-off

A receivables write-off is the accounting process of removing ARs deemed uncollectible from a company’s financial records. This action is necessary when it becomes evident that a customer will not pay the outstanding amount due despite reasonable collection efforts. Writing off receivables ensures that the company’s financial statements accurately reflect its expected revenues and assets.

Reconciliation

Reconciliation is the process of comparing and aligning the AR ledger or subsidiary ledger with the general ledger to ensure that all records and transactions are accurate, complete, and consistent. This process helps identify and resolve discrepancies between the two sets of records, ensuring that the financial statements accurately reflect the company’s receivables.

Risk management

Risk management is the process of identifying, assessing, and mitigating the risks associated with the potential non-payment of invoices by customers. Effective risk management helps a company maintain a healthy cash flow, minimize bad debts, and sustain financial stability.

Trade receivables

Trade receivables is another name for “accounts receivable.”

Transaction

A transaction is any activity or event that involves an exchange between a business and its customers, resulting in changes to the company’s AR balance. These transactions generally relate to the process of selling goods or services, including billing, payment, adjustments, and customer credit write-offs.

Real-world accounts receivable examples

Accounts receivable (AR) is essential to business operations and finance management in every industry. Here are a few of those real-world examples:

Construction

A construction company completes a portion of a building project and issues a progress invoice to the property developer with payment terms of net 45 days. The amount invoiced, but not yet paid by the developer, is recorded as AR.

Education and professional training

A private university charges students for tuition and fees at the beginning of the semester, with an option to pay in installments over several months. The amounts due from the students are listed as AR.

Healthcare

A medical clinic provides services to patients and bills their insurance companies. The amount billed but not yet received from insurance companies is recorded as AR on the clinic’s balance sheet.

Hospitality

A hotel provides conference services for a corporate event and allows the client to pay within 45 days after the event. The hotel records the amount as AR.

Manufacturing

A car parts manufacturer delivers a bulk order of components to an automobile manufacturer with a 60-day payment term. The car parts manufacturer records the sale as AR until the auto manufacturer pays the invoice.

Professional services

An accounting firm provides auditing services to a business client and issues an invoice with a net 30-day payment term. The amount billed becomes AR until the client makes the payment.

Real estate

A real estate agency records outstanding tenant payments for monthly rent billed, but not yet received, as AR on its balance sheet. Another example is when the business anticipates payment from a client for property management services provided during the previous month.

Retail

A clothing store sells apparel to a reputable department store chain with payment terms of net 30 days. The department store has 30 days to pay for the purchase. Until the clothing store receives payment, it records the outstanding amount as AR on its balance sheet.

Software and technology

A software company sells a subscription service to a corporate client with a quarterly billing cycle. The amounts due for the next billing period are considered AR until the corporate client makes the payment.

Supply chain transportation and logistics

A supply chain transportation and logistics provider considers outstanding payments from a retailer invoiced for freight transportation services as AR.

Telecommunication

A telecommunications company provides monthly services to its customers and bills them at the end of the month. The telecom company records the unpaid bills from the previous month as AR.

Wholesale distribution

A beverage distributor delivers products to several grocery stores and allows 30 days for payment. The beverage distributor records the amounts owed by the grocery stores as AR.

The difference between accounts receivable vs. accounts payable

Understanding the difference between accounts receivable (AR) and accounts payable (AP) is essential for business leaders and finance professionals. Both components represent different sides of a transaction and serve distinct functions in the financial health and management of a business.

By balancing these two elements, businesses can manage cash flow effectively, maintain strong relationships with suppliers and customers, and sustain smooth operations.

Accounts receivable (AR)

AR refers to the money customers owe a business for goods or services that were delivered or consumed but not yet paid for. When a company extends credit to its customers, the resulting balance is considered AR.

Appearing under the “current assets” section of the balance sheet, AR reports future cash inflows that the company expects to receive from its customers within one year. In financial statements, the line item demonstrates that the company is aware of expected cash inflows and can manage them effectively. This insight is crucial for maintaining adequate liquidity and supporting the company’s operations and growth.

Accounts payable (AP)

AP refers to the money a business owes to its suppliers or creditors for goods or services purchased on credit. When a company buys products or services but does not immediately pay for them, the obligation to pay in the future is recorded as accounts payable.

Appearing under the “current liabilities” section of the balance sheet, AP should be settled within a year. It’s tracked and managed like any other short-term business obligation to creditors to help ensure the business meets its financial commitments.

Effective management of accounts payable involves timely payment of invoices to maintain strong supplier relationships and avoid late payment penalties. However, it also requires careful cash-flow management to ensure the company has enough liquidity to meet obligations without compromising its financial stability. Balancing these factors helps the business optimize its working capital and maintain a healthy financial position.

How the accounts receivable process works

The main objective of the accounts receivable (AR) process is extending credit to a customer with the confidence that they’ll pay the debt soon after receiving the product or service. It begins when a company sells goods or services on credit and the terms of the sale, including payment due date and any discounts for early payment, are agreed on.

Step 1: Make the sale and send an invoice

After a company provides a product or service, it sends the customer an invoice. This invoice is a bill that shows how much the customer owes, when the payment is due, and any other pertinent details on agreed sales terms.

Step 2: Record the amount owed

Once the invoice is submitted to the customer, the company notes down the amount owed in the accounts receivable ledger. This indicates future cash flow the company expects to soon receive.

Step 3: Track what’s owed

The company keeps a close eye on unpaid invoices to help ensure timely payment. This may involve maintaining an aging report that lists invoices by date issued and categorizing them by time outstanding—for example, 30 days, 60 days, and 90 days. The schedule gives the company insight into on-time vs. late payments.

Step 4: Get paid and update records

When the customer pays the invoice, the company updates its records to reflect this. The finance team fixes any mistakes or differences in payment through a process called reconciliation. Reconciling the accounts receivable ledger with payments received helps ensure records properly match up.

Step 5: Collect unpaid invoices

Sometimes, customers don’t pay on time. When this happens, the company might send reminders or make phone calls. Other options include offering a payment plan, employing a collections agency, or writing off the debt as a loss.

Step 6: Assess doubtful accounts

When collecting an unpaid invoice appears unlikely, companies must keep a record of that doubtful account. Then, they can assess potential losses and plan for their financial future while considering the risk of working with that customer again.

How to record and track accounts receivable on the balance sheet

Proper management and accurate AR recording ensure that financial statements and accrual accounting practices reflect the company’s financial health.

Here are three accounts receivable examples that show how it can appear on a balance sheet alongside other items relevant to a company’s short-term financial position and liquidity.

Example 1: Simplified balance sheet

AR is listed as a current asset on the balance sheet, reflecting the debt’s short-term nature.

Example 2: Balance sheet with allowance for doubtful accounts

With a net accounts receivable approach, the net figure accounts for any allowances or adjustments for doubtful accounts. In return, you get a realistic view of expected collections.

Example 3: Balance sheet with detailed receivables

This contra-asset account approach estimates the portion of receivables that may be uncollectible, ensuring a realistic net AR figure.

How to optimize the accounts receivable process

Optimizing the accounts receivable (AR) process is essential for maintaining a healthy cash flow and meeting financial obligations.

The following strategies help improve cash flow, lower the risk of bad debt, and boost financial health:

Develop clear and specific credit terms

Defining payment terms, such as due dates and interest on late payments, and offering discounts for early payments help set expectations and reduce misunderstandings. This strategy ensures that customers know their obligations before finalizing the sales transaction.

Use software with automated invoicing capabilities

Automating the invoicing process with artificial intelligence (AI) reduces the time and effort of generating and delivering invoices. Automated systems reduce the likelihood of delays and errors by submitting invoices promptly and accurately.

Implement reliable payment tracking and follow-up tools

A comprehensive system for tracking customer payments is crucial for identifying overdue invoices and following up effectively. By monitoring payments closely, your business can promptly act on outstanding receivables. This approach reduces the risk of bad debt and improves overall AR management.

Offer multiple payment options

Providing customers with various payment plans makes it easier for them to settle their invoices. Options include online payments, credit card processing, and electronic funds transfers. This flexibility not only leads to faster payments but also improves customer satisfaction and loyalty.

Conduct credit checks on new customers

Before extending credit to new customers, a credit check process assesses their ability to pay on time. Reviewing a customer’s credit history for financial reliability mitigates the potential for late payments or defaults.

Incentivize early payments with discounts

Offering customers early-payment discounts improves a company’s cash flow and reduces costs associated with extensive follow-up.

Review and update collection policies regularly

Collection policies should evolve with business needs and economic conditions. Regularly reviewing and updating these policies ensures they effectively address current challenges and maintain an efficient AR process.

Improve processes based on data analytics

Data analytics identifies trends and areas for improvement in the AR process. Analyzing AR data reveals patterns in customer behavior, highlights inefficiencies, and guides strategic decisions to optimize the collections process.

Consider outsourcing accounts receivable management

Outsourcing AR workflows to a third-party provider is a viable option for businesses looking to improve efficiency and resource allocation. Professional AR services help streamline the process, reduce overhead costs, and allow internal finance teams to focus on core business activities.

Maintain continuous communication with customers

Building customer relationships with continuous communication encourages timely payments. Regularly engaging with customers through reminders, follow-ups, or personalized interactions helps maintain a positive relationship and fosters trust, making them more likely to pay on time.

Why integrate accounting software with cloud ERP

Traditional accounting software often struggles with issues like data silos, limited integration capabilities, and inefficiencies in financial reporting, especially as companies expand into new regions or scale their operations. By integrating financial management and accounting software with cloud ERP, finance organizations can overcome these challenges to accelerate accounts receivable (AR) processes, optimize overall finance operations, and enhance their financial health.

This integration streamlines finance processes such as invoicing, payment collection, and reconciliation, reducing manual errors and improving efficiency. Providing real-time data access, cloud ERP helps ensure that finance teams have the up-to-date information necessary to make informed decisions faster and follow up on late payments more effectively. It also improves collaboration between departments, further enhancing the accuracy and effectiveness of AR management.

Additionally, the ability to automate reporting, such as aging schedules and customer balances, helps organizations better track and manage AR for improved cash flow and financial stability.

The following benefits far outweigh the initial investment of creating a centralized, cloud-based AR platform, providing a foundation for business growth and financial stability.

Streamlined processes

Integrating accounting software with cloud ERP releases finance professionals from the burden of manual tasks in invoicing, payment collection, and reconciliation. With this unified platform, businesses can manage all finance processes in one place, ensuring tasks are completed faster, more accurately, and more efficiently.

Real-time data access

A key advantage of cloud ERP is accessing finance data anytime and anywhere. This real-time access ensures that finance teams stay up to date on AR so they can make informed decisions quickly. Whether following up on late payments or analyzing outstanding invoices, accurate, real-time data is crucial for effective AR management.

Automated reporting

Cloud ERP systems automatically generate detailed reports on AR, such as aging reports and customer balances. These give finance teams confidence when tracking, managing, and reporting receivables and identifying potential issues before they become significant problems. With automated reporting, businesses gain insights into their cash flow and improve financial forecasting in real time.

Improved collaboration

Integrating accounting software with cloud ERP enhances collaboration across different departments, such as finance, sales, and customer service. By centralizing finance data, everyone involved in the AR process can work from the same information, improving communication and coordination. This collaborative approach leads to more effective collections and better cash-flow management.

Enhanced financial visibility and control

Businesses gain a comprehensive view of their financial health as integration eliminates data silos. This single source of truth for all financial information provides the visibility to better monitor KPIs such as DSO and accounts receivable turnover ratios. Moreover, it empowers finance leaders to identify and take proactive measures that improve cash flow and reduce outstanding debts.

Scalability and flexibility

As companies grow, their finance processes become more complex. Cloud ERP systems scale with the business with ease—adding new capabilities, integrating additional software, and expanding into new markets. This flexibility ensures that the finance organization continues to manage AR efficiently, even as priorities, strategies, and processes evolve.

Increased security and compliance

Cloud ERP offers advanced security features that protect sensitive finance data from cyber threats and unauthorized access. Integrating accounting software with cloud ERP also ensures that financial records are consistently accurate and compliant with regulations. Additionally, process automation reduces the risk of human error, further enhancing data integrity and security.

Cost savings and efficiency gains

Moving accounting functions to the cloud reduces the need for manual labor and the associated costs. By automating routine tasks, finance teams can focus on strategic activities that add value to the business—such as financial analysis, planning, and decision-making—while reducing operational costs, increasing efficiency, and improving profitability.

Financial resilience through strategic accounts receivable optimization

Effectively managing accounts receivable (AR) is essential for maintaining a company’s financial health and ensuring smooth operations. By understanding the importance of AR and implementing best practices, businesses improve cash flow, reduce the risk of bad debt, and strengthen customer relationships.

Whether establishing clear credit terms, automating processes and workflows, or integrating accounting software with cloud ERP, optimizing the AR process is a strategic move that supports long-term growth and financial stability.

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