What Is Account Receivable Management?

Accounts receivable (AR) represents money owed to a business by its customers for goods or services that have been delivered but not yet paid for. These amounts are generated when a business extends credit to its customers, allowing them to receive products or services immediately and pay at a later date. AR is considered a current asset on a company’s balance sheet, signifying funds the company expects to collect within a short period, usually one year.

Accounts receivable management encompasses the systematic process of overseeing and administering the collection of these outstanding payments. It involves a series of activities designed to ensure that a business receives timely payment for its credit sales. The main objective is to optimize the billing, payments, and collections process to minimize the time it takes to get paid and to reduce the risk of uncollectible debt.

Effective accounts receivable management is important for a company’s financial health, directly influencing its liquidity and cash flow. Without proper management, a business can face delayed payments, potential bad debts, and issues with meeting its own financial obligations. This management process helps maintain a positive cash flow and fosters positive customer relationships by establishing clear payment terms and communication channels.

Key Processes in Account Receivable Management

Credit Policy and Customer Onboarding

Establishing a clear credit policy is the initial step in managing accounts receivable. This involves setting terms and assessing a customer’s creditworthiness before extending credit for goods or services. Businesses evaluate factors such as a customer’s financial stability and payment history to mitigate potential collection issues. This process helps determine appropriate credit limits and payment terms.

Invoicing and Billing

Once goods or services are delivered, accurate and timely invoicing is important. Invoices serve as a detailed record of the transaction, outlining the amount due, payment terms, and due dates. Prompt creation and dispatch of error-free invoices accelerate payment cycles and reduce disputes. Clear invoicing helps prevent delays and misunderstandings that can otherwise impact cash flow.

Payment Processing

Efficiently receiving and recording customer payments is another important process. This includes handling various payment methods, such as electronic transfers, checks, or credit cards. Payments must be accurately recorded in the accounting system to reflect the reduction in outstanding receivables. Streamlining payment processing helps accelerate the conversion of receivables into cash.

Collections and Follow-up

When payments become due or overdue, systematic collections and follow-up procedures are initiated. This often involves sending reminders through various communication methods like email, phone calls, or automated messages. The goal is to remind customers of their obligations and encourage timely payment, escalating efforts as necessary. Communication should be clear and professional, allowing for potential payment plans if a customer faces temporary difficulties.

Cash Application and Reconciliation

The final stage involves accurately matching received payments against outstanding invoices, a process known as cash application. This ensures that customer accounts are updated correctly and that the business has a real-time view of its cash position. Reconciliation involves comparing accounts receivable records with bank statements to ensure all transactions are accounted for and balances are accurate. This step helps identify and resolve any discrepancies, maintaining the integrity of financial records.

Tools and Technologies for Account Receivable Management

Accounting Software and ERP Systems

Integrated accounting software and Enterprise Resource Planning (ERP) systems are foundational tools for managing accounts receivable. These systems allow businesses to manage AR alongside other financial functions, such as general ledger, accounts payable, and payroll. They centralize financial data, which helps streamline operations and provide a comprehensive view of a company’s financial standing.

Dedicated AR Automation Platforms

Specialized AR automation platforms offer features designed to streamline and automate various AR tasks. These platforms can automate invoicing, send payment reminders, and facilitate cash application. Implementing such software can reduce manual effort, minimize errors, and accelerate collection cycles, thereby improving cash flow.

Electronic Payment Systems

Electronic payment systems play an important role in accelerating collections by providing customers with convenient payment options. These include online payment portals, Automated Clearing House (ACH) transfers, and credit card processing. Offering multiple digital payment channels can remove roadblocks for customers, making it easier for them to pay promptly.

Customer Relationship Management (CRM) Integration

Integrating Customer Relationship Management (CRM) systems with AR processes can provide valuable insights. CRM systems house customer interaction history, which can be useful for AR teams to understand customer behavior and tailor collection strategies. This integration helps ensure consistency in customer information across sales, service, and finance departments, which can improve credit management and customer relations.

Monitoring and Analyzing Account Receivable

Accounts Receivable Aging Schedule

An accounts receivable aging schedule categorizes outstanding invoices based on how long they have been due. It groups receivables into timeframes such as 0-30 days, 31-60 days, 61-90 days, and over 90 days past due. This schedule helps businesses identify which accounts are current and which are becoming overdue, allowing them to prioritize collection efforts and assess the likelihood of collection. The longer an account is past due, the less likely it is to be collected.

Days Sales Outstanding (DSO)

Days Sales Outstanding (DSO) measures the average number of days it takes a company to collect payment after making a credit sale. It is calculated by dividing total accounts receivable by total net credit sales, then multiplying by the number of days in the period. A lower DSO indicates that a business collects its receivables quickly, which is beneficial for cash flow. A high DSO can signal potential cash flow problems or issues with collection activities.

Collection Effectiveness Index (CEI)

The Collection Effectiveness Index (CEI) assesses the ability of a business’s collections staff to collect funds from customers. It compares the amount collected in a given period to the amount of receivables available for collection during that same period. A CEI closer to 100% signifies a highly effective collections process, indicating that a large percentage of available receivables are being converted into cash. This metric helps evaluate the efficiency of collection efforts and identify areas for improvement.

AR Turnover Ratio

The Accounts Receivable Turnover Ratio measures how efficiently a company converts its accounts receivable into cash within a specific accounting period. It is calculated by dividing net credit sales by the average accounts receivable over a period. A higher turnover ratio generally indicates efficient collection practices and a healthy cash flow, as the company is quickly collecting payments from its customers. A lower ratio might suggest inefficiencies in credit policies or collection procedures.