What Is the Accounts Receivable Process?

Elizabeth Macauley

You started your small business to make a profit. Now that you have, you may want to expand your operation even more. In 2017, 40% of small businesses said that improving customer experience and retention was their top strategy for increasing revenue growth. While it may seem surprising, the right accounts receivable process can do both.

Accounts Receivable Procedure

You’ve probably lent money to a friend before as an “I owe you” (IOU). In business, this is essentially what accounts receivable are. They are money owed to your business that customers have already spent, on credit.

Most of the time these IOU transactions go smoothly but, without the right process, they can get messy fast.

Successful accounts receivable processes follow these steps:

1. Establishing Credit Practices

Extending credit is risky. To help ensure that you have the highest chance of being paid back, you’ll want to establish a credit check system. This will allow you to look into each customer’s credit before they borrow from you. You can then weed out customers who are not likely to pay you pack. It’s as simple as not offering credit to customers with bad credit.

To establish your credit terms successfully, you’ll need to complete a few tasks. These include:

  • Deciding on the amount of credit you want to extend to each customer
  • Choosing the payment time period for your customers
  • Deciding if you want to offer early payment discounts and what those terms would be
  • Picking a penalty for late payments that you receive from customers
  • Identifying any other conditions specific to your small business that you want to include

Once you’ve established your basic credit terms, you’ll also want to consider:

  • How long your customer has been with your business. You may want to offer new customers shorter terms for payment and offer older customers longer terms. Rewarding customers who have stuck by you with longer payment terms may increase brand loyalty even more.
  • Your customers’ payment history. For customers who have always paid on time, you may want to be more flexible. For instance, say a customer—who has always paid on time—requests longer payment terms. Because they’ve never missed a payment, you may want to consider their request.
  • Your competitors. If competitors in your industry are sending invoices that are due within 20 days, then you may want to do the same. Or, if you can afford it, consider offering a longer period of time for customers to pay. This can give you a competitive edge.
  • Your cash flow. In certain cases, reducing your terms will allow you to get money back faster. This can help increase your cash flow.

Although these considerations may sound great, another question may be burning at the back of your mind: How do you check your customer’s credit?

Follow these steps to check your customer’s credit score:

  1. Obtain a signed authorization from your customer to run a credit check.
  2. Make sure you have their full legal name, date of birth, and Social Security number.
  3. Use Equifax, Experian, and TransUnion to submit online request forms.

2. Invoicing Customers

Communication is key in any relationship. This includes the relationship you have with your customers. Your invoice serves as the primary communication platform between you and your customer. This invoice communicates your transaction requirements directly to them. That said, keep in mind that your invoice is not a legal document.

Each invoice you produce should outline your products or services sold. You also should include the cost of those products or services, as well as the due date of the payment. After you have these components, you’ll want to continue improving your invoices by:

  • Making sure your information is as clear as possible. You want to avoid confusing wording or language.
  • Making sure your information is complete. Double check that you didn’t forget important parts of the invoice.
  • Making sure you don’t have unclear payment terms. Pay attention to your payment terms on your invoice. Any confusion on this can cause customers to reach out with questions. The more this happens, the more delayed payments you receive.
  • Using the right kind of numbering. Establishing an invoice numbering system is essential. You want to be able to track your invoices easily. Each invoice should have a unique number to allow easier tracking and identification.
  • Reviewing your invoices frequently. Always check your invoices for issues with grammar or calculations. Accuracy is a must.
  • Making sure you follow up. You want to make sure you follow up at the right times. You don’t need to harass your customers but, if they’re late on a payment, don’t be afraid to send a follow-up or make a call.
  • Use software for invoicing or online invoicing. Software can help you make consistent and accurate invoices for each transaction. For example, QuickBooks can help you make invoicing easier.

3. Tracking Accounts Receivable

You wouldn’t let a customer leave your small business without paying, right? Losing track of your accounts receivable is essentially that. You’re missing out on payments.

Staying on top of your accounts receivable is important. For invoices that have not been paid yet, you will want to fill out an accounts receivable ledger. This is a list of invoices that are due with a total amount at the bottom. The total should agree with the total accounts receivable reported on your balance sheet.

You also can use software to keep track of your receivables. For example, QuickBooks has the option to produce aging reports. These reports show you when an invoice is overdue and how much the payment is. There are also a variety of other accounting and bookkeeping applications you can look into. Some popular ones include FreeAgent, Nutcache, and Sage Business Cloud Accounting.

If you’re not ready to invest in accounting or bookkeeping applications, you also can use certain tracking templates. For instance, the invoice tracker spreadsheet from Microsoft Excel is a good option.

4. Accounting for Accounts Receivable

Your accounts receivable are essential components to your financial statements. This means you will need to record and account for them correctly. To do this, you’ll want to make sure you document your accounts receivable through your invoices—which should describe the goods or services you have provided the customer, the amount that is owed to you, and when that amount needs to be paid.

There are two methods of accounting to consider when accounting for your receivables. They are:

  1. Cash-basis accounting. In this type of accounting, your revenue is considered revenue when cash is received. Your expenses are considered expenses when you pay for them. For cash-basis accounting, you track your accounts receivable separately from revenue. Your revenue isn’t recorded until the cash is received.
  2. Accrual-basis accounting. In this type of accounting, your revenue is considered revenue when the sale is incurred. Similarly, your expenses are considered expenses when a cost is incurred. Your accounts receivable are recorded under this system. There is a risk the customer may not pay you. If they don’t pay, later you can charge these losses to expense.

The Evolution of the Accounts Receivable Process

Your accounts receivable can be documented by hand in templates or other preferred methods. You’ll need to manually create:

  • Each invoice
  • Each sales order
  • Each customer acknowledgement
  • All shipping documents

The more customers you gain, the more disorganized this can become. This disorganization can then disrupt your small business’s overall revenue. When your revenue is disrupted, your small business’s growth can be stunted.

Instead of pursuing this manual route, you may want to consider using accounting programs. You can gradually switch over to these programs, or you can implement them immediately.

Other tools you can use include:

  • Wave. This is a cloud-based accounting program that was designed for contractors and businesses with less than 10 employees. Wave is compatible with Mac, Windows, and Linux operating systems.
  • Invoice Ninja. This is an accounting program designed for freelancers and online entrepreneurs. It is 100% free and cloud-hosted, so it can be accessed anywhere.
  • FreshBooks. This is an accounting program that is used in 120 countries by over 500,000 users. Keep in mind that this program isn’t free but you can get acquainted with a 30-day trial.
  • Zoho Books. This is a cloud-based accounting software that focuses on invoicing, and is great for small businesses. It’s especially useful for small businesses that are owned and operated by one person.
  • Xero. This accounting software can help you with invoicing and tracking. It also does payroll, bank connections, bank reconciliation, and more.

Optimizing Accounts Receivable Processing

Your accounts receivable process helps keep your small business running efficiently. However, you’ll want to periodically optimize it, to keep it up to speed.

To successfully optimize your process, you’ll want to identify what’s working and what isn’t. From there, you can make tweaks that offer solutions to any identified problems. This will help you save money and avoid suffering losses. It also will help you reduce debt and increase growth over time.

To optimize your accounts receivable process, consider these steps:

  1. Discuss payment terms early with each customer.
  2. Use electronic payments early in the process.
  3. Keep your customer data accurate and up to date.
  4. Always look for ways to enhance and improve your collection process. One way to do this is by using electronic billing.

Are Your Customers Motivated to Pay Faster?

Your customers have a lot of bills to pay. Providing them with a little motivation to pay your invoice faster isn’t going to hurt.

Here are some tips for motivating your customers to pay faster:

  • Add a late fee. The risk of a late fee encourages your customers to pay as soon as possible and not take a chance of missing the due date.
  • Offer rewards for paying early. These are often addressed on the invoice directly. For example, if you are offering a 2% discount for paying in 20 days instead of 30, you would write “2/20 net 30.”
  • Use credit policies. You can put policies in place that prohibit taking an order from a customer if they’ve exceeded their credit limit. You also can put a policy in place that prohibits shipping items if a customer has any overdue invoices. These policies can encourage customers to stay up to date on their payments.

How to Collect Receivables Faster

Businesses, especially small businesses like yours, are always changing and evolving to fit their market. This means that even if your accounts receivable process is going smoothly right now, there are probably ways you can improve it.

Some ways to improve your accounts receivable collection process include:

  • Using software. Different accounting software can generate accounts receivable aging reports. These allow you to see each customer’s payment status. Your accounting software also will alert you if invoices are overdue.
  • Sending your invoices out right away. You don’t want to waste any time sending out invoices to your customers. The sooner they receive the invoice, the faster they can get the payment to you.
  • Following up on payments. You don’t need to badger your customers, but if they’re late, a follow-up can be in order.
  • Using electronic payments. Setting these up early can create a more efficient payment system. The easier it is for customers to pay you, the faster they’ll send them in. Electronic payment options include PayPal, Venmo, Square, Google Pay, WePay, and more.
  • Considering payment plans. These can be a good option for customers who are late paying what they owe.
  • Hiring a collection attorney. If late payments are becoming common for your small business, consider hiring a collection attorney. These attorneys can help you collect payments, handle paperwork, and even represent you in court if needed.
  • Accepting deposits upfront. This can be a useful strategy to help ensure your small business gets paid. In fact, most retail small businesses already do this. For instance, when you purchase an item on Amazon or another online store, your account gets charged well before you receive the item.

As you evaluate your process for handling accounts receivable, look closely at your overall procedure. All it takes are some easy adjustments to improve your small business’s efficiency. From there, you can continue to optimize your accounts receivable process and encourage your customers to pay faster. Remember that the faster your customers pay, the quicker you can collect your receivables. This leads to more growth financially in the long run.

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