Accounts receivable (AR) refers to the outstanding invoices a company has or the money it is owed from its clients.
AR represents a line of credit extended by a company, due within a relatively short timeframe, which could range from a few days to a year.
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What is Accounts Receivable?
If a company has “receivables,” it’s made a sale but has not yet collected the money from the purchaser. Most companies operate by allowing a portion of their sales to be on credit, offering their clients the ability to pay after receiving the product or service. For example, utility companies typically bill their customers after they have received electricity. While the utility waits for its customers to pay their bills, the unpaid invoices are considered accounts receivable.
Accounts receivable should not be confused with accounts payable (AP). AP is the debt a company owes to its suppliers or vendors. Accounts receivable is the debt of the buyers to the company. AR is an important assets to a firm, while AP is a liability that must be paid.
The accounts receivable process is a cornerstone of financial stability and growth for a business. Efficient management of accounts receivable not only helps a business maintain a healthy cash flow but it also supports customer relationships, risk mitigation and strategic decision-making.
What is the Accounts Receivable Process?
Businesses must set up an accounts receivable process to determine what customers have already paid and to identify any payments that are overdue.
Step 1: Establish Credit Practices
First, a company must develop a credit application process. Based on the credit-worthiness of the applicant, the business will decide whether or not to offer the customer goods on credit.
The company must also establish terms and conditions for credit sales. This includes a document that outlines the client’s obligations and requirements. The business must ensure that it complies with federal credit laws.
Terms and conditions may differ for large and small companies. Large companies may opt to give a customer longer periods of time for repayment. Small businesses generally cannot afford to offer goods on credit for longer periods.
Step 2: Invoicing Customers
An invoice is a document provided to the buyer detailing the products or services that have been rendered, the cost and the date payment is expected. Each invoice has a unique number for easy reference.
The customer is given the chance to choose whether they want to receive electronic or physical invoices. Electronic invoices are less expensive and more convenient.
Invoices must be sent promptly to ensure payment comes as soon as possible.
Step 3: Tracking Accounts Receivable
This step is performed by an accounts receivable (AR) officer. The officer enters payments into the AR system and allocates it to an invoice.
The officer also reconciles the AR ledger to be certain that all the payments are accounted for and properly posted. Then they issue monthly statements to clients. A statement provides details for the customers about the amounts owed per previously sent invoices.
The business may handle this tracking process manually or automatically. In a manual process, companies use spreadsheets to record when they send the invoices and when they receive payments. Automated systems use accounts tracking software to help ensure accuracy. The system assists the AR officer by flagging outstanding debts.
Step 4: Accounting for Accounts Receivable
The accounting department makes journal entries to record sales, including unpaid debts.
Other Elements of the Payment Process
The purchasing department places an order and transmits a copy of the purchase order (PO) to the AP department. The organization receives the goods or services (either through the receiving department or the employee who ordered them) and the vendor sends the invoice to AP.
💡 Learn more about the procure-to-pay process.
An AP clerk manually keys the invoice data into an accounting system before physically storing the paper document in a filing cabinet. New supplier information is entered using the organization’s naming conventions to avoid duplication. Both new and existing supplier information is checked for accuracy against internal sources, such as the master vendor file, and external sources, such as the IRS TIN matching service and the U.S. Treasury Department’s Office of Foreign Control (OFAC) list of organizations that are banned from business in the United States.
Learn more about electronic invoicing.
An AP clerk conducts a three-way match, comparing the PO, the receipt and the invoice to identify any inaccuracies or mismatched data. An AP manager prepares and approves paperwork for any exceptions for short delivery, damaged items, wrong items or other issues.
When a supplier calls the AP department to ask where the payment stands, an AP clerk researches the question and determines whether the invoice is still in the approval process or if the payment is on its way.
Learn more about vendor management.
The information technology (IT) department monitors the company’s enterprise resource planning (ERP) system and any hardware and software the AP department is using. The IT team approves and installs new versions of software as needed.
The IT team considers any proposals from AP for new technology and determines how to integrate it with the company’s legacy systems.
Learn more about AP automation software.
Reports and Analysis
The AP department prepares and studies reports, analyzing all transactions, monitoring the department’s performance and metrics. The CFO oversees the organization’s cash flow through conversations with the AP team. The CEO receives written and verbal reports from the CFO on the performance of the organization.
Learn more about automated AP reporting.
Manual financial processes waste valuable resources for businesses. To learn more about how AvidXchange can handle vendor management and automate your company’s AP processes, click below to schedule a demo.