Your accounts receivable play a critical role in your company’s financial health. This article breaks down the process of managing receivables.
As a new business owner, you may not be familiar with the concept of accounts receivable. Nonetheless, it's a critical part of the accounting cycle that you can't afford to ignore. If you ever sell goods or services to customers on a credit basis, you will always have an accounts receivable balance.
The totals of your accounts receivable directly impact your company's net income because they are considered revenue. Since they are already factored into your total revenue, however, collecting your receivables does not impact your retained earnings, nor do closing entries affect your accounts receivable.
Keep reading to learn more from Hoist about how you can prepare to manage your receivables.
In the simplest terms, your accounts receivable are the money your customers owe for any products or services you have sold them on credit. If you have invoiced for a product or service, it counts as a receivable.
Your business' balance sheet should include the total value of all your accounts receivable as current assets, as well as invoices for any goods or services sold to customers on a credit basis.
It is standard practice for a vendor to invoice customers after selling an item or performing work. Vendors and customers usually agree on terms before issuing a purchase order or signing a contract. Most terms state that customers will pay an invoice within 30 days (net 30) to 60 days (net 60), though companies sometimes agree to net 90 to secure an important contract.
If a business sells a large order of a made-to-order product, it's common to request an upfront deposit. Many service firms will bill a portion of their fees upfront as well. When your business delivers a good or service to a customer, you should invoice the customer and record the amount in your accounts receivable. And be sure to include the terms of the purchase order or contract.
Once your customer pays the invoiced amount within the agreed-upon timeframe, you can record the payment as a deposit and remove it from your accounts receivable.
If the customer does not pay their bill on time, you will need to send a letter with a copy of the original invoice or employ other strategies to get paid.
You record your accounts receivable and accounts payable in your business's general ledger. Your receivables are considered assets, while your payables are liabilities. To get an accurate overview of your company's financial standing, you must keep track of your payables and receivables.
To break it down: Every invoice issued is receivable to one entity and payable to another.
Since you expect to receive the money within the established timeframe, your accounts receivable are considered assets. Accounts payable, however, are liabilities because you must pay the amount during the defined period.
While there are similarities, your company should keep your accounts receivable and accounts payable separate. If you have the resources, dedicate a different department to each one. Segregating these duties can help prevent fraudulent activity and help your business maintain healthy accounting practices.
While you don't want to complicate your business operations needlessly, having different departments or personnel handle your receivables and payables can maintain accountability for human error and intentional unethical behavior.
For instance, you may not want the same individual paying bills and entering invoices. You might even consider having one of your employees note receipt of customer payments and another enter the payments to your balance sheet.
While accounts receivable and accounts payable are two distinct elements, they work together to paint a picture of your company's financial health. They essentially tell you how much your business is owed and how much your business owes others.
Combined with other sound accounting practices, managing your receivables and payables can help you set the stage for a better cash flow and a brighter future.
Getting paid on your accounts receivable is critical. It is how you will finance your daily operations, pay your staff, invest in opportunities, and ultimately grow your business. If you get to where you're not collecting payments on time, it can put your company in a precarious situation.
Too many small businesses face challenges in managing their accounts receivable. Issues often stem from customers taking too long to pay, paying less than the agreed-upon amount, or being unable to pay because of economy-driven setbacks. You can minimize these problems and position your company for a healthy financial future by taking a few practical measures.
Perhaps the most fundamental method of preventing late or missed payments is to check the credit history of every customer before you extend credit. Remember that you are essentially loaning customers your own money, and you want to feel secure that you will get it back. You will need to approach credit case by case, as some customers will need different credit terms than others.
One tip is to consider only checking credit history if you’ll be extending credit over a certain limit. This goodwill from you can speed up service and maintain, or even build, goodwill with your customers.
Before extending credit to a customer, try to obtain their credit report, which would present their payment history, bankruptcy records, any relevant lawsuits and judgments, and a risk rating. This rating estimates the customer's likelihood to pay their bills on time.
You also may want to evaluate a customer's credit references. Know that these are not 100% reliable but can provide you with valuable information. If you are selling to another business, request a comprehensive list of current and past suppliers so that you can call some of them to find out if the potential customer has neglected payments.
Another step to consider if you are trying to determine whether or not to extend credit to a business is to review their primary financial statements. This is an easy task for a public company because you can gauge its ability to repay based on its balance sheet.
Look at the potential customer's current ratio, which compares its existing assets and liabilities. A current ratio less than 1-to-1 can be a red flag, while 2-to-1 or greater is reasonably safe.
Anytime you choose to extend credit to a customer, make your payment terms crystal clear. Your customer should know an estimate of the expenses they will incur, and you should make an arrangement that will provide convenience to your customer without compromising your company's bottom line.
While you're at it, ensure your team knows how to act and respond regarding billing. Your company needs to have a clear and consistent billing process that every team member can follow.
This includes establishing invoicing dates and billing periods, the information that shows up on each invoice, and solid recordkeeping procedures. Your team should also have a system for collecting overdue payments and consider conducting an occasional accounts receivable assessment to address any concerns.
Along with addressing each credit extension case by case, you may include unique billing details for each customer in your documentation. Along with billing contact information, keep notes and payment details for each customer.
Moreover, have credit and collection policies in place so that all of your employees will know whether your company should extend credit to a customer that requests it. Establishing credit policies will also prevent you from providing too much credit to the wrong customer. And setting collection policies will help your team proactively resolve overdue accounts.
Snail mail billing and paper checks take too long to track, and they are easy to lose. Fortunately, technology makes it easy for companies to send invoices via email through easy-to-use apps. There are many invoicing apps on the market that you can quickly find on the internet. Now is the time to implement an electronic invoicing system that helps your customers make quick and easy online payments.
What's more, you don't have to wait for the monthly billing cycle to come around because you can shoot over an invoice immediately after selling a product or service. This can go a long way in helping your customers prepare for the due date. Plus, many invoice apps will allow you to see when a customer has accessed the email, which gives them one less excuse for paying you late (or missing a payment altogether).
If you opt for software that integrates payment processing, customers can pay directly from their bill with just a click, and the software will immediately record the payment. Furthermore, using an electronic invoicing system automates your recordkeeping, which helps you minimize human error and gives you less information to keep track of.
You can also establish customized periodic reminders when you encounter late payments. In other words, your company can improve its payment collection process while communicating uniquely with each customer, all while saving time.
Customers often fail to make payments on time because the business does not offer quick and convenient payment methods. Make it easy for customers to pay you by providing various payment options.
Yes, you want to accept credit cards, PayPal, and other popular payment methods, but consider allowing your customers to pay you through bank transfers or direct debits. It's also a good idea to establish an electronic payment portal where clients can pay online after reading your invoice.
Digital wallets like PayPal and Google Pay let people store several bank account numbers and credit cards in a single secure environment. When customers use this payment method at a business, they only have to hold their phone over the scanner to complete the transaction. This is one of the most convenient ways for your customers to pay.
Another option to consider is bank transfers, which allow customers to transfer funds to your company during a purchase. This process is used to require a bank branch to distribute money to a merchant’s account and then for the merchant to match the payment of the purchase before you fill the order.
Now, many online bank transfer options streamline these transactions. A customer can begin the transfer while paying on your website, and an automated payment match speeds up the order.
When a customer uses a direct debit to pay for a good or service, the funds come directly out of the customer’s bank account. Because all communication occurs between banks, there’s no need for card networks with this payment method.
Direct debits are excellent options for recurring customers. Simply enter their bank account information in your system to start automatically drawing payments.
Moreover, if you regularly sell products and services online, think about setting up an electronic payment portal on your site. The interface should be clean and straightforward, and you can use it to provide customers with a range of payment options.
As we have covered, your company's accounts receivable are any sales you have made from which you have yet to receive partial or full payment. The primary purpose of using accounts receivable is to provide customers with a more manageable, long-term payment plan or the opportunity to establish or build credit.
No matter what type of business you run, managing your accounts receivable can yield many benefits. Let's discuss a few of the most common ones:
When you have a process for managing your accounts receivable, you can track customer credit. Acquiring the data of past plans and purchases of each customer will help your team make informed decisions regarding extending credit to each customer. For example, a customer with a positive repayment history could be ideal for credit, while a questionable record could present red flags.
Along with helping you determine whether or not to extend credit to each customer, analyzing historical data can also give you an idea of the amount you should offer. If you work with digitized account receivable files, you can organize them by various metrics, including the type of credit purchases, pay-off duration, and many other factors.
Another essential component of well-maintained accounts receivable is that you can quickly identify your uncollected profits. If your company hopes to collect past due payments, set up repayment plans with customers, and execute your collection protocols, you must have access to non-payment data.
Furthermore, if your company finds itself in judicial, mediation or arbitration proceedings from your attempts at collections, your accounts receivable data will prove valuable.
It is long-established that businesses that provide flexible payment options for their customers enjoy major sales advantages. This includes letting customers buy goods and services through credit accounts, long-term payment plans, and IOUs.
Essentially, your company allows customers to purchase in good faith, which can go a long way in establishing a reputation for goodwill and loyalty among customers. In turn, this sets the stage for increased sales in the future. However, to get the most out of your sales, you must keep your accounts receivable highly organized and easy to reference for each customer.
Ultimately, when your accounts receivable department is a well-oiled machine, it benefits your financial and customer management strategy, which leads to healthy business growth and development. By analyzing your customers' purchasing and borrowing trends, you will have valuable information for creating new marketing strategies and sales goals, which can expand your customer reach and take your growth to the next level.
If you want a significant sales advantage, your company should consider offering credit and long-term plans to your customers. But to take full advantage of these payment options, you must manage your accounts receivable effectively.
Keep researching the ins and outs of accounts receivable and start coming up with solutions with your team to manage these accounts better. In no time, you will feel secure in your process and determine whether to extend credit to each customer (and how much).
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