How Does Accounts Receivable Work?
When a business sells products or services to a customer, it may offer credit terms, allowing the customer to pay at a later date. This process creates an accounts receivable balance on the business’s financial statements.
The terms often specify when payments are due, such as within 15 days, 30 days, or 60 days, depending on the agreement between the business and the customer. During this period of time, the business tracks its accounts receivable balances, ensuring that customer payments are collected in line with the agreed payment terms.
Companies rely on their accounts receivable to maintain steady cash flows and support their working capital needs. For example, if payments are delayed beyond the due date, it can negatively impact cash flows, leading to potential challenges in meeting short-term obligations.
What Are Examples Of Accounts Receivable:
Here are a few practical examples of how accounts receivable works:
- Product Sales on Credit: A technology company sells $10,000 worth of goods to a customer, allowing the customer to pay within 30 days. The $10,000 becomes part of the company’s accounts receivable until the customer pays.
- Service Invoicing: A consulting firm provides services worth $5,000 to a client and issues an invoice with 60-day payment terms. The $5,000 is counted as accounts receivable until payment is made.
- Late Payments: If a client doesn’t pay their $2,000 invoice within the agreed 30 days, the business will still list the amount as part of accounts receivable but might also need to take steps to collect payments
The Difference Between Accounts Receivable And Accounts Payable
While accounts receivable refers to the money a business expects to receive, accounts payable is the money the company owes to its suppliers for products or services received. Both play important roles in managing cash flow but have opposite effects on the balance sheet. Accounts receivable are assets, whereas accounts payable are liabilities. Balancing these two elements is essential as part of healthy financial management.
What Are The Types Of Accounts Receivable?
There are various types of accounts receivable. This includes any invoices for goods and services the business provides to a customer without payment at the time of reporting. The payment of the invoice is expected on a date in the future (typically in 60 days or less). Here are the different types of accounts receivable:
| Type Of Accounts Receivable | Description |
| Trade Accounts Receivable | This is the most common type of accounts receivable and arises from a company’s normal business activities. It represents the money owed to a company by its customers for goods or services that were provided on credit. These accounts are typically short-term, meaning customers are expected to pay within a specified period. Trade accounts receivable is recorded as a current asset on the company’s balance sheet and plays a crucial role in maintaining cash flow. |
| Interest receivables | Interest receivables refer to the amount of interest income that a company or individual is entitled to receive but has not yet collected. This typically arises from lending activities or investments that accrue interest over time. |
| Notes Receivable | This type involves formal agreements where the customer signs a promissory note, committing to pay a certain amount by a specific date. These are often longer-term compared to standard trade receivables. |
| Factored Accounts Receivable | When a business sells its receivables to a third party (a factor) to get immediate cash, the accounts receivable are classified as factored. This process is known as factoring and helps companies with cash flow. |
| Employee receivables | Employee receivables refer to amounts of money that employees owe to the company as a result of cash advances or loans. |
| Vendor receivables | Vendor receivables refer to amounts of money that a company expects to receive from its vendors or suppliers. |
| Insurance claims receivables | Insurance claims receivables refer to amounts of money that a company or individual is entitled to receive from an insurance company as reimbursement for a filed claim. This arises when a company experiences a loss or damage that is covered by its insurance policy, and it has submitted a claim for compensation. |
Best Practices When Dealing With Accounts Receivable And Finances
Establishing strict measures to manage accounts receivable and finances is critical to improve cash flow, minimize bad debt, and strengthen your business’s financial health. Here are a few best practices to follow:
- Set Clear Payment Terms: Define payment due dates and penalties upfront.
- Automate Invoicing: Use software such as invoicing software, automated reminders, and payment processing software to streamline invoice generation and tracking.
- Review Receivables Regularly: Monitor overdue accounts and aging balances.
- Implement a Collection Policy: Have a process for handling late payments.
- Offer Multiple Payment Methods: Make it easy for customers to pay.
- Check Customer Credit: Evaluate creditworthiness before extending credit.
- Provide Early Payment Incentives: Encourage quicker payments with discounts.
- Track Key Metrics: Monitor days sales outstanding (DSO) to improve collections.
- Separate Financial Duties: Ensure different roles handle billing and payment processing.
- Reserve for Bad Debt: Set aside funds for uncollected receivables.
Managing the accounts receivable process is crucial for ensuring strong cash flow, minimizing the risk of bad debt, and maintaining healthy net working capital. Playroll’s solution for finance teams, helps businesses streamline their financial operations, including simplifying global payroll, payment processes, and compliance management. Book a chat with one of our experts to find out how we can help you consolidate your operations.
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