What Are the Effects of Providing Services on Account?

When a business provides services to customers “on account,” it means the service is rendered immediately, but payment is not collected at that moment. Instead, the customer is extended credit, agreeing to pay for the service at a later date. This practice allows businesses to serve clients without requiring upfront cash, fostering trust and convenience. It sets the foundation for a financial relationship where the business anticipates future payment for work already completed.

Impact on Revenue and Receivables

Providing services on account directly influences how a business recognizes its income and manages its financial assets. Under common accounting practices, revenue is formally recognized when the service is performed, regardless of when the cash is actually received. This method provides a clearer picture of a business’s earning activities over a period, aligning income recognition with the delivery of value to the customer.

When a service is completed and payment is not immediate, an asset known as “Accounts Receivable” is created. Accounts receivable represents the money owed to the business by its customers for services already delivered. These amounts are promises of future payment, typically collected within one year. They indicate the total value of sales that have been made on credit and are still awaiting collection.

However, extending credit introduces the possibility that some customers may not pay their outstanding balances. This risk is accounted for through “bad debt,” which refers to amounts a business expects to be uncollectible. When a business anticipates that a portion of its receivables will not be collected, it records a bad debt expense, which directly reduces its reported income. This adjustment helps present a more accurate view of the business’s profitability.

Cash Flow and Liquidity Implications

While recognizing revenue when services are performed provides an accurate measure of earnings, it does not mean the business has received cash. This timing difference means a business can show a profit on its financial statements yet face challenges in having enough cash to cover its daily expenses. The funds are tied up in accounts receivable until customers complete their payments.

This delay significantly impacts a business’s liquidity, which refers to its ability to meet short-term financial obligations like payroll, rent, and supplier payments. An increase in accounts receivable means more capital is tied up in unpaid invoices, rather than being available as liquid cash for operations. Maintaining sufficient working capital, which is the difference between current assets and current liabilities, ensuring funds are available for ongoing operations, is crucial. Without effective management, a business might struggle to pay its bills even if it is otherwise profitable.

To bridge potential cash flow gaps caused by outstanding receivables, businesses may need to explore short-term financing options. These options can include lines of credit, which allow access to funds as needed, or more specialized solutions like invoice financing or factoring, where receivables are used as collateral or sold for immediate cash. Such financing can provide the necessary liquidity to maintain operations and pursue growth opportunities while awaiting customer payments.

Managing Credit and Collections

Effectively managing services provided on account requires establishing clear processes for extending credit and collecting payments. A business must implement well-defined credit policies that include assessing a customer’s creditworthiness before offering services on account. These policies typically specify payment terms, such as “Net 30” or “Net 60,” indicating that payment is due 30 or 60 days from the invoice date. Some terms may also offer a small discount, often 1% to 2%, for early payment to encourage quicker collection.

Once services are rendered, timely and accurate invoicing is crucial. Invoices should clearly detail the services provided, the amount due, and the payment terms. Consistent follow-up on outstanding invoices is needed, which may involve sending reminders as due dates approach and making direct contact for overdue amounts.

Managing accounts receivable also involves various operational costs. These expenses include the administrative time and resources dedicated to generating invoices, tracking payments, and conducting follow-up activities. In cases of persistent non-payment, a business might incur additional costs for collection services or legal fees. Businesses often consider charging late payment penalties, typically ranging from 1% to 2% of the overdue balance per month, to incentivize timely payments and offset these administrative burdens.

Maintaining positive customer relationships while pursuing collections requires a careful balance. Clear communication and firm collection efforts are essential for financial health, but overly aggressive tactics can strain customer goodwill. The goal is to ensure payments are received efficiently while preserving the business relationship. This balance helps a business manage its finances effectively without compromising its reputation.