Accounts receivable is a crucial part of a company’s balance sheet. It helps you identify incoming money owed to your business for products sold or services rendered, which is part of your working capital and can even be used as a liquid asset.
As a business owner, you’ll want to ensure you’re keeping tabs on your pending invoices and assets. Here's how to start tracking your business’s accounts receivable, plus tips and tools for ensuring you get paid on time.
What is accounts receivable?
Accounts receivable refers to money that customers or clients owe your business for products or services you’ve already delivered. These pending transactions are typically tracked via client invoices, which include the work performed, the amount owed, the due date, and any additional payment terms.
Your accounts receivable balance is considered an asset on your company’s balance sheet, even without money in hand. This is because, when you send an invoice, you are essentially extending credit to a client. The client is then legally obligated to pay this debt, and as such, your business has a reasonable expectation of collecting that payment.
Accounts receivable is distinct from accounts payable, which refers to any outstanding bills your business owes for products and services (excluding payroll). Accurate tracking of both is necessary to fully understand your business’s financial position.
[Read more: What Is an Accounts Receivable (AR) Aging Report?]
How to record and track accounts receivable
To start tracking accounts receivable, follow these steps:
- Submit the invoice: You’ll have to first create and send an invoice to your client. You should do this as soon as possible after a job is completed so as not to delay payment and hurt your cash flow.
- Track invoice status: Once sent, track the status of your invoice and be sure to follow up with the client if payment is not issued by the due date.
- Record payment: Record the paid invoice in your books. Be sure to record in the proper manner depending on whether you’re using the cash basis accounting method versus the accrual basis accounting method.
- Assess your methods: The recording process will help you identify any gaps or concerns in your invoicing. If you’re facing issues with cash flow due to late or nonpayments, consider whether you’re allowing too much time for clients to pay their debts. You might even consider sending periodic invoice reminders or offering incentives for early payers.
To better understand how well you handle your accounts receivable, you might want to determine your accounts receivable turnover ratio. The higher the ratio, the better off you are. To calculate it, simply divide the net credit sales over a specified period by the average account receivables:
Accounts receivable turnover = Net annual credit sales / Average accounts receivables
Your accounts receivable directly impacts your cash flow, and it’s crucial to keep up to date on your invoices. If necessary, don’t be afraid to make any adjustments to your payment terms if it will help your business.
[Read more: Accounting Basics Every New Business Owner Should Learn]
While “flexing” your contract may feel like a kindness that puts your business in a positive light, it could inadvertently set a precedent that late payments are acceptable.
Tools to optimize accounts receivable management
There are several small business–friendly software solutions that can help you streamline accounts receivable management. Here are just a few and their key features:
- NetSuite, which has an automated accounts receivable management and reporting system that integrates with other internal solutions.
- QuickBooks Online (QBO), which can automatically track and send invoices, collect payments, and flag late payers.
- Wave Accounting, which can create invoices and accept online payments, as well as generate receivables reports.
Alternatively, you might consider outsourcing your accounts receivable to a professional. A small business accountant or accounting firm can ensure accuracy while freeing up time for you and your internal time.
How to reduce late payments and bad debts
When working with accounts receivable, on-time payments are crucial to maintaining steady cash flow and avoiding unexpected debt. These expert tips can help you reduce late payments, bad debts, and other accounts receivable issues.
Be clear and firm in your payment terms
At the onset of any contract or work agreement, establish your payment terms up front, including due dates, penalties for late or missed payments, and any processes in the event the client is unable to pay. Make sure your clients understand their obligations fully; have everything in writing (for all parties) to avoid ambiguity.
Once you’ve set and reviewed your terms, it’s critical to hold your clients accountable to them. While “flexing” your contract may feel like a kindness that puts your business in a positive light, it could inadvertently set a precedent that late payments are acceptable.
“Be stern in your payment terms, as well as [in] setting the expectation of consequences with late payments beyond just charging a late fee,” advised Christian Maldonado, Founder & COO at TaxAdvisor365. “This could include stopping service until payment is made or stopping delivery of product, for example, depending on the type of business you run.”
Automate the invoicing process
Kathy Gilchrist, Founder and Chief Financial Officer at Cardinal Bookkeeping & Advisory, recommends using automated software to streamline the invoicing process and increase the likelihood of getting paid.
“QBO has a built-in invoicing feature that small businesses can use to schedule and plan their invoices to avoid chasing payments from their clients,” Gilchrist said. “Automating invoicing also reduces the amount of time spent on administrative tasks, which increases the business's efficiency.”
Incentivize early and on-time payments
A bit of incentive can go a long way in encouraging clients to pay on time or early.
“For persistent late payers, consider offering small discounts for early payments or imposing penalties for late payments to encourage timely settling of accounts,” advised Li Han Tan, Co-Founder and Principal Consultant of W.L.P. Group.
Offering — and rewarding the use of — auto pay or card-on-file payments can also reduce the likelihood of late invoices, according to Chris Rivera, Founder of The Ecommerce Accountants.
“This minimizes missed payments and streamlines cash flow, saving time on collections,” Rivera explained. “Many clients respond positively to discounts or rewards for choosing auto pay options.”
[Read more: App-based Employee Expense Tools for Small Businesses]
Sean Peek also contributed to this article.
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