What is Accounts Receivable (AR)?
Successful businesses understand just how important it is to maintain a balance between expenses and income, and the accounts receivable process plays an important role in helping businesses achieve their growth targets. Many businesses offer goods on credit, which is why the accounts receivable is such an important department that directly impacts a company’s profitability.
In accounting terms, accounts receivable simply refers to the short-term debts that the company is owed by its debtors. These are sales made on credit, and the company records them once goods are delivered, in accrual accounting. This is essentially a line of credit offered to clients.
When goods are delivered, the company issues an invoice to the buyer. The sum of all outstanding invoices is the accounts receivable. These are current assets, and customers have a legal obligation to clear the invoices. The company also expects debtors to clear the invoices within a year or less in most cases.
A number of companies now offer their standard services on credit. For instance, debtors may purchase goods worth X amount from the company in large quantities without paying anything upfront. Since goods are delivered, the company records the value of X in its accounts receivable account in the general ledger.
When the debtor clears the payment, the company reduces the accounts receivable, and credits cash instead. The amount owed to a company is simply referred to as the accounts receivable.
The accounts receivable process refers to the policies and workflows established by the business for onboarding new customers or issuing lines of credit to them.
Here’s a broad overview of how the accounts receivable process works:
Before onboarding a new customer, the company must evaluate a new customer’s risk profile. This helps prevent later issues with rising bad debts and ensures that due process is followed when bringing on a new customer.
If the company has any defined credit limits or specific terms, such as shorter payment deadlines for new customers, they must be followed.
The company uses the purchase order to gather relevant information and then uses it to prepare the invoice. The invoice has a specific number (the invoice number), which corresponds to the purchase order (PO) number. This allows for easy tracking throughout the invoice approval process.
After generating the invoice, the company then sends out the invoice to its debtors. Invoices can either be sent manually, via postage, or via email. The invoice should be sent out promptly so that the customer can process it and release it before the deadline.
Some companies also offer discounts for early or timely payments, which helps boost relationships and improves cash flow.
Tracking invoices is also critical in the AR process, as it allows the company to accurately track all payments being received. Once outstanding invoices are cleared, they’re then filed into different repositories. Accurate tracking, especially with the help of software, is recommended.
Not all customers are likely to pay their outstanding debts. In some cases, if a company is liquidated, they may not be able to clear their debts. As a result, the business must record a bad debt. To prevent this from affecting the company’s bottom line excessively, most companies prepare a provision account known as provision for doubtful doubts.
The AR function is responsible for accounts receivable aging, which gives them a better understanding of the frequency of late payments, customers that frequently pay late, and the risk associated with dealing with such customers.
If the company feels a customer is a credit risk, they can reduce their credit line or discontinue it altogether.
Most of the work in the AR department is generally repetitive, with accountants having to sift through mail and go through transactions to track payments. Then, they stamp the dates and make changes to the customer’s account in the general ledger.
To improve the quality of work in the AR department, many companies now prefer automating key functions. Automating accounts receivable helps reduce processing costs, decrease AR turnover days, and significantly improves credit control as well.
With SoftCo’s Accounts Receivable (AR) Portal, companies can gain full visibility over billing documents, including invoices, proofs of delivery, statements, and other details. SoftCo eBilling allows customers to register on an online portal to track payments in lieu of running after them over the phone.
Automating the AR function results in the following benefits:
It’s one of the best ways for businesses to quickly reduce their administrative and processing costs, without having to increase credit risk or worry about missed invoices.