Accounts Receivable Process

The accounts receivable process is a multi-layered system that an accounting staff structures and implements to manage payments owed to the business.

 Accounts receivable are payments owed to the business from customers for services or products delivered. The customer has not paid for the goods or service received at the time of the transaction. Instead, the business has extended credit to the customer and expects to receive payment for the transaction at some point in the future.

The method of communicating these debt obligations to customers, monitoring their payments, and ensuring that proper and complete payments are received involves several separate processes. Together, they comprise the accounts receivable process which is designed to ensure that the business receives the money owed to it so that it can maintain a steady cash flow for continued operation.

The accounts receivable process follows a cycle, beginning when the customer purchases an item or service from the business.

The cycle ends when payment has been collected for that purchase. A number of steps occur from beginning to end to help move the process along. These include invoicing, extending credit to the customer, monitoring and following up on payments, collecting full payment from the customer, and recording and reconciling payment in the general accounting ledger.

Accounts receivable consists of several different steps or processes within the larger process:

1. Purchase and purchase orders: There are no accounts receivable before there are sales. When a customer intends to purchase a good or service from the business, a purchase order details the pending transaction. Once it is approved, a sales order confirms the transaction.

2. Credit: Accounts receivable assumes that a transaction is made before payment has been received, and this implies that the customer has made a purchase on credit. Businesses adopt a series of policies and procedures that govern the extension of credit. It is very important for a business to evaluate a customer's creditworthiness before they make a purchase on credit to reduce the risk that the customer will default on payments.

3. Invoicing: Once a purchase has been made and the customer has been approved for credit, an invoice will document the details of the transaction. Typically, this includes such information as the name of the entity or unit providing the good or service, the recipient of the good or service (the customer), the good or service provided, the date on which it was provided, the quantity or amount that was provided, and the value of the resource that was exchanged. The details of the invoice are important to ensure that all parties to the transaction have the correct information.

4. Collections: All accounts receivable must eventually be collected. Just as businesses have credit policies and procedures, they have procedures in place for collecting payment. Collections management refers to the systems, methods, and procedures that a business has in place to oversee collections of unpaid bills from customers. An aging report tells a business how many days accounts receivable are outstanding. Dunning letters are sent to customers making them aware of outstanding payments.

5. Bad Debt: In an ideal world, all customers pay all their bills on time, all the time. In the real world, some customers do not. Some accounts receivables must be written off as bad debt. This is used to offset the short-term value of accounts receivable.

6. Cash Application: Once accounts receivable are collected, payments must be matched to the outstanding invoices they correspond to. Incoming cash can’t be utilized by a company until it has been properly assigned. It is important for a business to have an effective cash application process so incoming cash can be put to use quickly and efficiently. The sooner the money is applied, the sooner it can be used to pay salaries and bills, fill purchase orders, invest in other opportunities, and pay dividends to investors.

7. Dispute Resolution: Occasionally, customers may dispute invoices or collections. Businesses must have an effective dispute resolution process that it can employ to maintain good customer relations and process accounts receivable quickly.

8. Reporting/Analytics: Finally, once outstanding payments are received, businesses can analyze their accounts receivable. They employ various metrics to evaluate the effectiveness of their accounts receivable process. Metrics like the receivables to sales ratio, receivables turnover ratio, and days sales outstanding measure the volume of accounts receivable as a proportion to sales and the time it takes the business to convert receivables into cash. These help the business evaluate how much risk it is exposing itself to concerning payments from customers and how effective it is in collecting payments.

Businesses can do many things to ensure their accounts receivable process is efficient and effective.

1. Establish and Maintain Good Communication

All good systems involving customers require good communication. Expectations and guidelines concerning credit policies must be clearly conveyed to customers so they know what their payment obligations will be.

2. Maintain Accurate Invoices

Well-written, accurate invoices go a long way toward communicating the details of the transaction, including price and payment due, to the customer. Accurate information in the invoice ensures that there will be no misunderstandings leading to disputes after the transaction has already occurred.

3. Create Well Written Credit Policies and Guidelines

Well-written credit policies and guidelines help the business establish a comfortable level of risk, attract customers who fall within that level of risk, and provide guidelines to those customers about their payment obligations, as well as the interest, fees, and deadlines that will apply to their purchase.

4. Understand Your Customer

Businesses should also be flexible with customers and understand their behavior. Similarly, the business should give customers multiple options for payment. This includes incentives, like discounts for early payments. We live in a world of choices and customers will appreciate the opportunity to pay in the manner of their choosing. They also appreciate a nudge. Some customers don't pay until they are reminded.

5. Accounts Receivable Aging Process

An effective aging process allows the business to track and properly rank or prioritize outstanding payments. The aging report organizes individual accounts receivable into groups depending on how much they are past due. The typical groupings are:

●       0-30 days

●       31-60 days

●       61-90 days

●       more than 90 days

The aging report will help the business organize and evaluate the status of its accounts receivable, which informs the process of collections. On that note, data is an essential ingredient.

6. Ensure Your Data is Accurate

Accurate data about transactions and outstanding payments will inform the rest of the process and enable the business to make good decisions about the steps that it takes for collections.

7. Establish A Good System for Monitoring Payment Reminders

A good system for monitoring and following up on payments is essential. Dunning letters are a standard form of reminder for customers. A systemized approach to sending letters ensures accuracy and consistency in the process.