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8 Min. Read

What is Accounts Receivable Process?

What is Accounts Receivable Process?

To serve customers and clients, businesses often make arrangements to accommodate different payment scenarios. Not only does this process provide flexibility to customers, but it also ensures that businesses receive the funds they are due.

The Accounts Receivable (AR) process is one example. When businesses offer credit to paying customers, these transactions are filed under Accounts Receivable and are collected at a later date. Strong accounting policies ensure that outstanding and unpaid invoices are paid promptly.

Keep reading to learn how business owners can tailor this process to assist customers and ensure continuous cash flows. 

Here’s What We’ll Cover:

What are Accounts Receivable?

5 Important Steps in the Accounts Receivable Process

Accounts Receivable Automation

Special Circumstances for Accounts Receivable

Journal Entry for Accounts Receivable

Accounts Receivable vs. Accounts Payable

Key Takeaways

More Accounting Resources for Small Businesses

What are Accounts Receivable?

Accounts Receivable (often abbreviated AR or A/R) is an accounting term that refers to any of the following. 

  • Unpaid or outstanding invoices
  • Money that is expected from customers
  • Late payments 
  • Sales issued on a credit card or any credit system to be paid at a later date

AR includes payments for goods and services rendered by a business on specific credit terms. This system also implies that anticipated payments are legally binding and enforceable. 

In an accounting system, Accounts Receivable is recorded on the balance sheet as an asset of the company issuing the good or service.

The Accounts Receivable Cycle

The A/R cycle usually involves a straightforward process for alerting customers and clients about the money they owe. A standard Accounts Receivable workflow includes the following steps.

  • The initial agreement or sales conversation
  • The creation of an invoice with a specific due date
  • Reminders at set intervals for outstanding invoices
  • Updating the accounting software to reflect payments that have been received

When managing this cycle, businesses should set realistic expectations. For example, the average time to payment for A/R is 27 days. As a result, businesses must keep track of every payment status and make plans to cover operational costs if there is any delay in receiving cash. 

Who Uses Accounts Receivable?

Many businesses offer unique payment plans for customers, and any industry can benefit from an effective A/R workflow.

The A/R process can include freelancers who send invoices for completed work and anticipate payment within a short time. It may also include large corporations, such as electric or utilities companies, that provide essential services and bill customers with the expectation of payment by a due date.

As for the individuals responsible for handling transactions and monitoring charges, this depends on the business structure. Although freelancers can manage their own invoices, larger companies have designated accounting professionals to keep the balance sheet up to date.

5 Important Steps in the Accounts Receivable Process

Now that you know what Accounts Receivable is and why it's valuable to various business models, you might be wondering how to get started. The five steps outlined below provide a foundation for creating a simple and effective Accounts Receivable process.

1. Establish credit application policies

Any business that wishes to use an Accounts Receivable ledger must first set boundaries and definitions when offering credit. It's important to answer the following questions before establishing the credit process.

  • Will every customer be eligible to use a credit or invoice system?
  • Are there any situations that mandate immediate payment?
  • Will there be any requirements before a customer is eligible for credit?
  • What are the terms and conditions for these kinds of sales?
  • What will the credit approval process involve? Who oversees it?

Failing to make these distinctions beforehand can result in overly casual business policies that lead to delayed or missing payments. Furthermore, it's crucial that both sales team members and accounting professionals understand the credit terms so that everyone is on the same page about cash flows.

2. Invoice and provide documentation to customers

Customers and clients that are familiar with an Accounts Receivable process should expect to receive notification of the money they owe. As this is standard practice, many customers wait to see the final amount before issuing a payment. Businesses have several options when it comes to documentation, including:

  • Paper invoices
  • Electronic invoices 
  • Monthly statements

The Accounts Receivable process can't move forward without a billing or invoicing step. Developing an organized process for creating and sending invoices is critical.

3. Set specific deadlines

Without due dates and payment terms, your customers may forget to make payment on time. Before sending invoices, make a decision about the deadlines that work best for your accounting department and bookkeeping process. While some companies can operate on Net 30 terms (paid monthly), others need cash upon receipt.

Design all invoices to include these due dates in a highly visible spot so that clients understand their obligations. Keep in mind that even with stringent policies, your accounting team may need to chase payments occasionally. Don't be afraid to adjust your deadlines based on customer behavior.

4. Track and monitor Accounts Receivable

Tracking Accounts Receivable is vital for financial success, but the exact process may differ between small and large companies. This is mainly due to the amount of time, resources, and staff available.

Regardless of company size, a designated individual should be able to report on outstanding and paid invoices, the balance sheet, and the reconciliation of assets. 

Specific analytics tools, such as an Accounts Receivable Aging Report, make it easier to monitor the length of time between initial invoice and payment. Different accounting software programs may have unique options to assist with A/R tracking. 

5. Square up accounting for AR

The A/R process is not complete without specific accounting actions that record the payment of invoices and sales. Incoming payments should always be recorded (either manually or within an accounting program), and each payment should be connected to a specific invoice number for reference.

The individual responsible for Accounts Receivable usually updates the balance sheet, makes adjustments for bad debts, and accounts for anything unpaid.

Realistically, in the course of business, some invoices may never receive payment. Even in these situations, it is important to record the appropriate information so that each account (including debits, credits, and assets) represents real-time information.

Accounts Receivable Automation

While it's always best to monitor Accounts Receivable and to maintain a hands-on approach, there are several new technologies and tools that make the process easier. As businesses grow, it may be especially helpful to offload a portion of the responsibilities onto automation tools and software.

Many new software choices are also cloud-based, which means they can be updated and accessed from anywhere. This provides greater transparency and visibility to modern organizations that conduct business remotely and at all times.

Special Circumstances for Accounts Receivable

There may be some occasions in which a business wants to offer a customer an exclusive discount, savings, or incentive. These exemptions can be incorporated seamlessly into the A/R workflow, particularly when using an automated accounting software like FreshBooks.

Accounting departments may need to occasionally record prepayments, overpayments, and account credits. Although these transactions are more complex than standard payments, it's important to understand how to accommodate these unique circumstances in the course of everyday business.  

Journal Entry for Accounts Receivable

The journal entry method for A/R is important when using accrual accounting. In the accrual system, the accounting department records a transaction whether or not a cash payment has been received. This step should credit the 'Sales' account and debit the 'Accounts Receivable' account.

Once the business receives payment from a customer on a specific invoice, the 'Cash' account receives a debit, and the 'Accounts Receivable' account is credited.

This exact process depends on which accounting method your business uses. Familiarize yourself with the procedures, and take time to educate team members about how a given method affects the Accounts Receivable process.

Accounts Receivable vs. Accounts Payable

While Accounts Receivable refers to money that a company expects to collect from customers, Accounts Payable refers to the money that a business must pay. Accounts Payable (AP) usually takes the form of recurring bills, operational costs, and general expenses.

Although different in purpose, there are similar processes and best practices for handling an Accounts Payable workflow. For larger businesses, it's helpful to separate these two realms of accounting and designate an individual or team to each one.

Key Takeaways

The Accounts Receivable process is crucial for many industries that rely on credit as a way to increase sales and cash flows. Although offering services on credit is a fairly standard business operation, developing a solid A/R collection process is crucial for success.

Accounting professionals must be prepared to work with individual customers and their needs, follow up with overdue accounts, and record accurate transactions using the chosen accounting system.

The best practices in this guide allow businesses to achieve quicker payments. Additionally, strong A/R habits can minimize unpaid debts, ensure correct financial records, and contribute to a company's growth.

More Accounting Resources for Small Businesses