What is accounts receivable?

Accounts receivable (AR) is the money owed to your business for goods or services already delivered. We’ve got all the information you need to master this much-needed part of running a business.

Why accounts receivable matters

Accounts receivable refers to the amount of money customers owe you. Here’s a quick and easy accounts receivable example:

• You invoice a client on Monday.
• The invoice remains unpaid on Friday.
• That invoice value is now part of accounts receivable.

On your books, you track this in an accounts receivable account. It might also be called a receivable account, and it lives within your accounts receivable ledger.

So why does it matter? Because it affects your cash balance and your company’s overall liquidity. It also impacts your planning efforts for payroll and suppliers.

Is accounts receivable an asset? Yes. Your company expects to collect cash soon, so AR is a current asset on the balance sheet.

Accounts receivable vs accounts payable

The difference between accounts receivable and accounts payable is simple. AR is money coming in, while your payable accounts is the money going out.

How does the accounts receivable process work?

The accounts receivable process includes the following steps:

1. Create customer invoices including your payment terms.
2. Send the invoice and double-check the invoice date.
3. Track the due date and expected payment date.
4. Send invoice reminders and payment reminders.
5. Reconcile payments when the customer pays.
6. Escalate late accounts or, as a last resort, write off bad debts.

How do you record accounts receivable?

You can record accounts receivable using the accrual accounting, which means you recognise revenue when you invoice. When you issue an invoice, it can either be debit (i.e. accounts receivable account) or credit (i.e. revenue account)

When the client pays, a debit (dr) enters your cash account and a credit (cr) becomes part of your receivable account. That credit line is your credit entry and it lowers your company’s accounts receivable.

The best way to manage all of this is to use accounting software to eliminate the potential for errors. The best platforms will make sure all your financial data is solid and even automate matching for your convenience (and fewer admin headaches).

What is an accounts receivable ageing report?

An accounts receivable ageing report lists unpaid debts by age and shows every outstanding invoice and how late it is. Most reports group debts into different time categories like:

• 0–30 days
• 30–60 days late
• 60–90 days late
• 90+ days late

It also shows who is consistently late – both your late paying customers (aka trade debtors).

Why produce an accounts receivable aging report?

Accounts receivable aging reports help gauge the following:

• Cash flow: You see where money is stuck and then target the biggest bottlenecks first.
• Debt policy: You can tighten up payment terms in your purchase agreement. You can also add deposits or change payments rules.
• Estimating bad debt: Forecast bad debts sooner to plan for bad debt expense and write-offs.

Here in Australia, if you need to write off a debt as bad, you’ll need to make sure that happens before you can claim a bad debt deduction. This is important if you’ve already paid tax on that income.

What is the accounts receivable turnover ratio?

This is a ratio that measures collection speed. In other words, it shows how fast your customers pay. The formula is easy:

Accounts receivable turnover ratio = Net credit sales ÷ Average accounts receivable

A higher ratio usually means faster collection, whereas a lower ratio is probably a sign of slower cash conversion. Track it monthly and compare it with changes in net credit sales.

How can I get paid faster?

Getting paid faster on your invoices doesn’t involve quick tricks. You need systems that work. Here are some systems that have proven to reduce the time customers take to pay.

Automatic reminders

Use automated reminders in your accounting software. Send invoice reminders before the due date and send payment reminders after the due date.

Strict terms and penalties

Set clear payment terms in writing, put them in the invoice and purchase agreement. Make penalties known, but keep them reasonable and enforceable.

Down payments/early payment/deposits/upfront

Ask for a deposit before work starts. Offer an early payment discount when it makes sense, as it could lift your cash conversion speed. There is also the possibility of upfront payments, which can be used if your business has an established reputation.

Frictionless payments

Give customers easy payment options: card, direct debit and bank transfer links. Fewer clicks lead to faster full payment while also improving the consistency of customer payments.

eInvoicing

This sends invoice data system-to-system, thereby reducing mistakes and speeding up delivery. Since July 2022, eInvoicing capability has become mandatory for non-corporate Commonwealth entities to receive eInvoices.

What is accounts receivable financing?

Accounts receivable financing (also called receivable financing) lets you get cash earlier. A lender or factor advances funds against unpaid invoices, which can be supremely helpful when cash is tight. It can also stabilise a temporary gap in your working capital.

But make sure you know the trade-offs, as fees will reduce your margin, and some deals shift customer communication over to finance companies.

Accounts receivable in a nutshell for small business

Whether you’re starting out or established, accounts receivable will be part of your everyday accounting process. By reviewing incoming payments, overdue invoices, and cash flow forecasts, your business will need to track accounts receivable reliably to ensure you’re paid on time.