What Is the Accounts Receivable Process?

Accounts receivable represents the money owed to a business by its customers for goods or services delivered or used but not yet paid for. It is a current asset on a company’s balance sheet, reflecting short-term debts owed by customers. Effectively managing accounts receivable is fundamental to a business’s operational liquidity, directly influencing its ability to cover expenses and invest in growth. A streamlined accounts receivable process ensures timely cash inflow, which supports ongoing operations and maintains financial stability. This process encompasses a series of steps designed to facilitate prompt payment and minimize the risk of uncollectible debts.

Setting Up Customer Accounts and Credit Terms

Before any sale involving credit occurs, businesses establish customer accounts and define credit terms. This preparatory phase involves collecting necessary information from new clients, such as legal business names, addresses, and tax identification numbers. A thorough credit assessment involves reviewing credit reports from agencies like Dun & Bradstreet or obtaining financial statements. This assessment helps determine a customer’s creditworthiness and the maximum credit limit a business is willing to extend.

Based on the credit assessment, specific payment terms are then agreed upon and formally documented. Common terms include “Net 30,” meaning payment is due 30 days from the invoice date, or “Net 60,” allowing 60 days. Businesses might also offer early payment discounts, such as “2/10 Net 30,” which grants a 2% discount if paid within 10 days, with the full amount due in 30 days. These terms are recorded in the company’s accounting system, like QuickBooks or SAP, creating a customer profile that governs future transactions and facilitates accurate billing. This initial setup establishes the framework for all subsequent financial interactions.

Creating and Distributing Invoices

After goods or services are provided, an invoice is created. An invoice serves as a formal request for payment and a record of the transaction. Each invoice is assigned a unique identification number and includes an itemized list detailing goods or services, quantities, and unit prices. The total amount due, payment terms, and the due date for payment are clearly stated.

Invoices typically include the seller’s business name and contact information, the customer’s billing and shipping addresses, and the date the invoice was issued. The timing of invoice generation varies; it might occur immediately upon product delivery, upon completion of a service, or at predefined intervals for ongoing projects. Businesses commonly distribute invoices through various methods, including email as a PDF attachment, traditional postal mail, or via secure electronic customer portals. Regardless of the method, the goal is to ensure the invoice reaches the customer promptly and accurately.

Receiving Payments and Managing Collections

Once an invoice is issued, businesses focus on receiving payments and managing outstanding balances. Businesses facilitate payment through several channels to accommodate customer preferences, including traditional paper checks, electronic transfers such as Automated Clearing House (ACH) payments, wire transfers, or credit card transactions. Upon receipt of payment, cash application begins, with the payment being accurately recorded in the accounting system and applied against the outstanding invoice. This involves matching the received funds to the correct customer account and invoice number.

Despite clear terms and multiple payment options, some invoices may become overdue. When an account becomes past due, businesses initiate a structured collection process. The initial step involves sending polite payment reminders through email or automated messages a few days after the due date. If payment is still not received, subsequent communications become progressively firmer, escalating from reminder calls to formal dunning letters outlining consequences, such as late fees or temporary suspension of services. These late fees are a percentage of the overdue amount, ranging from 1% to 2% per month, or a flat fee.

The collection process aims to recover outstanding funds efficiently while maintaining positive customer relationships. Businesses may establish a tiered approach with different levels of outreach based on the aging of the debt. For example, accounts 30-60 days past due might receive calls, while those 90 days or more overdue could face more intensive collection efforts, or a collections agency. Maintaining detailed records of all communication and payment attempts is standard practice throughout this collection cycle.

Reconciliation and Reporting

The final steps in the accounts receivable process involve reconciliation and reporting. Reconciliation is the process of comparing internal records of payments received with outstanding invoice balances to identify discrepancies. This involves matching bank deposits to recorded cash receipts and ensuring applied payments reduce invoice amounts in the accounting system. Should a discrepancy arise, an investigation is initiated to determine the cause, ranging from customer error to internal processing mistakes.

Accounts receivable aging reports are a primary tool for managing outstanding balances and are generated regularly. These reports categorize outstanding invoices based on how long they have been overdue, in 30-day increments (e.g., 1-30 days, 31-60 days, 61-90 days, 90+ days). This categorization provides a clear visual representation of the health of the receivables and helps prioritize collection efforts for older, higher-risk debts. Other important reports include collection effectiveness reports, measuring collection success, and Days Sales Outstanding (DSO), indicating the average days to collect receivables. These reports provide insights into financial performance and help businesses refine their credit policies and collection strategies.