However big or small your business is, you’re familiar with the notions of accounts receivable and accounts payable as integral parts of accounting. These two ledger lists are available on your balance sheet and indicate how well your business is performing. They act as two sides of an equation – if you neglect either side, it will affect the financial health and stability of your venture.
If you’re training to become a certified public accountant or you already work as a CPA offering a wide scope of services, the accounts are part of your CPE training and you probably know everything there is to know about them. But if you’re a business owner trying to make sense of your finances, it’s good to master the basics. Understanding what each account is and how it functions is a must so that you can track your cash flow and know your current financial standing.
Today we’d like to focus on accounts receivable – what it is, how it works and why it’s important to know the difference between accounts receivable and accounts payable. Ready? Let’s dive in!
- How do I track accounts receivable?
- What happens to the accounts if clients never pay?
- What happens if clients eventually pay?
What is accounts receivable (AR)?
An account receivable (AR) is the money that a company will receive from a customer for purchasing a product or service on credit. The credit period ranges on average from a few days to a year. The word “receivable” means that a business hasn’t received the payment yet but will do so in the future and the money is considered an asset in a company’s balance sheet. This data is stored in the “current assets” tab of a balance sheet or chart of accounts.
Understanding the accounts on your balance sheet: receivable vs payable
There are two types of accounts, so you need to understand the difference.
As already mentioned, accounts receivable is the asset account of a business that describes the money customers owe your business. Accounts receivable software is a helpful tool to manage this asset.
Accounts payable works the other way around. It’s the money your business owes and is described as a liability account in your balance sheet.
For example, you’re an owner of company A and bought goods from company B on credit. For your business, the payment will be recorded as an account payable, and for company B, it will be listed as an account receivable.
Dive deeper into the Differnce between Accounts Receivable and Accounts Payable.
Understanding the accounts receivable process
While the notion of accounts receivable is explained, you must have a clear idea of how the accounts receivable process works.
How do I track accounts receivable?
When it comes to recording sales that you haven’t received payments for, you have to understand what accrual accounting is.
The word “accrual” means that an entry is made in your books each time a revenue has been made or an expense has been incurred but without the actual money transfer. Such entries are put in an accounting system where accounts receivable or accounts payable are stored.
When you sell an item on credit, the sale is recorded in your books dependent on the receipt. It’s possible that you might not receive the cash when you expect. With accrual accounting, you record a transaction regardless of whether the payment was made or not. Then you create an invoice that automatically makes a credit for this sale in the sales account and makes debit in the accounts receivable.
What happens to the accounts if clients never pay?
When it becomes obvious that an invoice won’t get paid not only according to payment terms but at all, the account should be written off as a bad debt expense.
If a payment or receivable is no longer collectible due to the client not responding for a long time or not being able to pay because of going bankrupt or any other reason, such a receivable is determined to be a bad debt expense.
Monitoring such accounts as bad debts is useful in order to make estimates of how much less money your business will receive due to these kinds of debts.
What happens if clients eventually pay?
If after a long time you eventually receive the payment from your client, you’ll have to debit the cash account to get this account back to your books, then you’ll need to repeat the process – credit your receivable, and finally close it.
Why you need accounts receivable
Accounts receivable should be tracked by a business of any size. If some customers didn’t pay once, you don’t want to deal with these customers again.
Unreliable customers who don’t pay on time can lead your company to debt and bankruptcy if you don’t pay attention to what happens to your accounts receivable balance and whether all your invoices are paid. Keep track of your customers’ accounts so that you and your business never experience liquidity problems.
Accounts receivable turnover ratio
Accounts receivable is a significant part of a company’s financial health analysis. It’s a simple way to estimate an organization’s liquidity or capacity to cover current financial obligations without the need to use additional finances.
If you want to see how fast your customers pay their debts, you need to pay attention to the accounts receivable turnover ratio, which estimates the number of times a business gathers its average accounts receivable during a fiscal period.
The formula for accounts receivable turnover ratio is:
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
The ratio is expressed as a number, and the higher the number, the better.
The accounts receivable turnover ratio is also called the efficiency ratio, and it shows how efficiently a company manages its assets and capital.
AR turnover in days
Accounts receivable turnover in days helps businesses to understand how many days it takes to collect a credit payment. The formula is as follows:
Receivable turnover in days = 365 / Receivable turnover ratio
The accounts receivable turnover ratio is a productivity proportion and a marker of the financial and operational performance of a business. A high proportion indicates that the accounts receivable that a company collects is continuous and proficient. A high accounts receivable turnover likewise demonstrates that a business has a great client base who can pay off credit swiftly. A high proportion can also show that a business follows a traditional flow like net-20-days or even net-10-days.
Conversely, a low records receivable turnover proportion explains that a company’s way of collecting payments isn’t stable. This can happen when you stretch out credit terms to non-reliable customers who are already in financially difficult situations and are unable to pay or pay way past payment dates.
It’s also helpful to compare the accounts receivable turnover ratio between the main competitors or the same companies within one industry. It’ll give a more significant insight into a company’s performance as opposed to reviewing the number of disengagements. For example, if your company’s ratio for accounts is five, it may not be high in general. But we’ve got some great news – if you work in an industry where the average ratio is three, it may be more than enough.
Accounts receivable aging schedule
An aging schedule is a table that shows a company’s accounts receivable, ranging by due dates, which is usually created by accounting software. This schedule helps with tracking the upcoming payments from customers so a business owner knows when and what to expect.
The aging schedule for your accounts usually has the following categories: current (under 30 days) and past due (typically within 1-30, 30-60, 60-90 days, and more than 90 days).
These schedules are often used to see which customers need payment reminders because the company is often dependent on this money and has to make its own payments as well. If clients don’t pay on time it can cause financial distress.
The aging schedule can also show which clients don’t pay systematically. Based on this information, a company may make a decision to cut further deals with such clients.
What to do to have fewer overdue payments
To have fewer overdue or unpaid invoices and encourage your clients to pay on time, you can do the following:
- Make timely payments more attractive. Offer a discount for early payments. For example, 2% OFF if they pay within 72 hours after placing an order.
- Send reminders regularly. You can send reminders to clients to make them pay on time. With accounting solutions such as, for example, Synder, you can set automatic reminders so that you don’t have to worry about forgetting something.
- Cut ties with clients who are always late on paying. Unreliable customers always slow down your business growth. No need to keep these clients by your side because they don’t provide profit.
- Hire a CPA who will supervise your accounts receivable, accounts payable at all times. Have someone offering the necessary services – tweaking the accounts when necessary.
Managing your receivables with Synder
If you’re looking for ways to streamline your AR process and have a clearer picture of your cash flow, it’s time to think about automation. We’ve got some great news! Synder is a full service accounts receivable solution that can help you deal with your accounts quickly and without errors.
Synder connects to all your sales channels and payment gateways and posts all your transactions – sales, fees, discounts to your accounting software. There are many things you can automate with Synder in order to better manage your accounts receivable.
Firstly, Synder can automatically close open invoices whenever a client pays what’s due. You’ll no longer need to manually search for a certain invoice you created to credit a particular payment of your client. Check out this 40-second video to see how smooth the process is:
Secondly, Synder can send thank you emails for paid invoices with the help of the Smart Rules feature. Make your clients feel important and appreciated to develop good business relationships with them, while ensuring the accuracy of your accounts.
Thank you emails aren’t the only thing you can set within Smart Rules. You can send automatic payment reminders to your customers to have fewer overdue payments in your accounts receivable. Make your reminders friendly and polite so people will feel good about buying your products or services again.
Last but not least, Synder offers instant actionable insights from your financial data with Synder Business Insights. Now you can track all the necessary metrics in one source of truth and use your data with confidence. If you’re a CPA looking to widen the scope of your professional services, Synder Business Insights will help you provide advisory services and make you indispensable for planning business strategies.
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Closing thoughts on managing your receivable and understanding your cash flow
Accounts receivable is important for your business because it’s one of the main parameters to estimate your business income. Managing your receivables may be a daunting task as sometimes you can be misled by the unreliable clients who can’t pay on time. You need to be able to spot them, and encourage them to pay punctually, which might take some time.
One of the first steps to facilitate the process of managing your accounts may be trying out Synder – an accounting solution that will make supervising your accounts receivable easier and help you get insights for future improvements. Managing the accounts for a large company or small business should be efficient, and Synder’s got the functionality you need. Whether you’re a business owner trying to make sense of your accounts, or a CPA offering a wide scope of services, automation is the key to unlocking more time and resources.
If you have any questions on how Synder works, feel free to ask questions in the comments, chat or book office hours with our customer service team. In case you’re curious to try things out on your own – sign up and activate your 15-day free trial (no credit card required).
Stop worrying about the details in your accounts – leave them to Synder and focus on the big picture!