A Manager’s Guide to Accounts Receivable in Finance

Most companies use an accounts receivable model in their finance department to manage incoming payments. Accounts receivable differs from other financial departments or concepts like accounts payable or sales in a number of ways. Understanding how accounts receivable functions can help ensure your company remains in good financial health. Learn what accounts receivable is, understand the benefits of accounts receivable, review common terms used in accounts receivable, assess tips for effective accounts receivable management and read answers to frequently asked questions about accounts receivable. 

 

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What is accounts receivable? 

Accounts receivable is a designation for money that a customer or client has agreed to pay in exchange for a service or product, but that they have not yet provided. Accounts receivable is most common for businesses with high-value products that may require payment plans. Offering payment plans or an extended payment period is a useful strategy with advantages for both the company and the customer. 

Most businesses manage their accounts receivable using the following steps: 

  1. Provide an invoice: Once the customer has received the product or service, the accounts receivable department sends an invoice with information like the total amount owed and the payment due date to the customer.
  2. Record the amount owed: The accounts receivable department records the amount owed by the customer in the company’s accounts receivable tracker or software program.
  3. Collect the payment: The customer provides payment or, if necessary, the accounts receivable department secures payment with the help of a collections agency. 
  4. Balance the accounts: The accounts receivable department records the date and amount of the payment in their accounts receivable tracker or software to balance the accounts. 

Related: 5 Accounts Receivable Specialist Interview Questions and Answers

 

Benefits of accounts receivable 

Consider the benefits accounts receivable can offer your company: 

  • Build loyalty: Providing customers the opportunity to pay over time rather than demanding payment upfront can help establish customer loyalty. 
  • Track credit: With customers who have made a past purchase or past purchases, you can make individualized decisions about the type of payment plan you offer to meet your needs and the needs of the customer. 
  • Understand profits: Tracking accounts receivable should help your company better understand how much money you actually have in your accounts and how much money you’re owed in outstanding payments.
  • Develop organization: Developing an accounts receivable department can help you establish an effective overall financial strategy and organization for your company. 

Related: How to Hire an Accounts Receivable Specialist

 

Common terms used in accounts receivable 

A few common terms used in the accounts receivable department include: 

  • Accounts receivable turnover rate: This metric shows how effective the company is at collecting outstanding payments from customers. 
  • Average collection period: This metric is the average amount of time it takes for the company to actually collect the payment from the customer. 
  • Current liabilities: This metric expresses the company’s outstanding debts owed to other companies or creditors. 

Related: How to Write Accounts Receivable Specialist Job Description Sample

 

Tips for maximizing accounts receivable payment

Use these tips to help you improve the likelihood of receiving payment from your customers and clients: 

  • Provide invoices: Ensure your customers know how much they owe for their purchase and when their payment is due by providing accurate and timely invoices. 
  • Build relationships: Establish a relationship with your customers outside of the accounts receivable department. The more rapport your business has with the customer, the more likely they are to pay their bills on time. 
  • Give terms: Make sure your customers know the specific terms of their payment contract, understand when payment is due and know the repercussions for not paying on time. 
  • Use software: Use a software program that makes it easy to send payment reminders to customers, enter payments and thank clients from one place. 
  • Make payment easy: Give your customers multiple options for making a payment, with at least one online option. The easier it is for the customer to pay, the more likely they are to do it. 
  • Communicate frequently: Consider sending more than one invoice to customers, particularly as their payment date gets closer. Frequent reminders will help them remember to pay on time. 
  • Include penalties: Add late payment penalties to the payment contract. Knowing they’ll have to pay more money long term if they miss their payment deadline will entice most customers to pay by the due date. 

 

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Frequently asked questions about accounts receivable

What is the difference between accounts receivable and accounts payable?

Accounts receivable and accounts payable track opposite financials. Accounts receivable tracks payments owed to the company from customers or clients that have not yet been paid while accounts payable tracks expenditures and owed payments from the company to vendors or creditors that have not yet been paid. Both accounts receivable and accounts payable record impending payments rather than actual expenditures or revenues.

What is an example of accounts receivable?

Many industries and specific companies use accounts receivable as a part of their sales and financial processing. Consider this example:

Paul’s Pools sells pools and hot tubs. Nearly all of the company’s customers enter into a payment plan, since the products are costly. However, the customers receive their pool or hot tub before they complete their full payment. Paul’s Pools monitors and tracks the amount the customer owes after receiving their product through accounts receivable.

How do you calculate the accounts receivable turnover rate?

The accounts receivable turnover rate illustrates how well a company collects outstanding payments from customers. To calculate the accounts receivable turnover rate, use this formula:

Net credit sales / ((starting accounts receivable + ending accounts receivable) / 2) = accounts receivable turnover rate

Accounts receivable is a common practice for many companies. Consider the benefits of using accounts receivable for your business and the best practices for ensuring you receive payment from your customers.

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