How to Calculate Cash Collections from Accounts Receivable

30 April, 2024
10 mins
Rachelle Fisher, AVP, Digital Transformation

Table of Content

Key Takeaways
Introduction
What is Cash Collections?
How to Calculate Cash Collections from Accounts Receivable?
8 Methods of Cash Collection
10 Steps of the Cash Collections Process for Accounts Receivable
What Are the Challenges of Cash Collections
How Can HighRadius Help?
FAQs

Key Takeaways

  • Cash collections refers to the total amount of payments collected from customers in exchange for goods and services.
  • It can be calculated by adding your cash sales with the estimated collections from accounts receivable. 
  • The best way to achieve high cash collections is to embrace AI and automation software for smart collections.
keytakeway

Introduction

Cash is the center of the trade business world. Managing your cash effectively can therefore be one of the most important things you can do to keep your progress steady through the ups and downs of the economy. 

Cash flow is critical to the success of any business. Effective cash collection is crucial for maintaining a positive cash flow.Cash collection accounting can help you understand your cash position to plan for the future and avoid instabilities before they happen. In this blog we will help you understand the importance of cash collections, how to calculate it, and the solutions to challenges many businesses face with cash collections. 

What is Cash Collections?

Cash collection refers to the payments that you collect from your customers in exchange for goods and services. It can be collected in two ways: first, through cash sales, where they pay you immediately, and second, on accounts receivable, which refers to when customers take credit and pay later. 

For example – You have two customers who are buying goods from you. The first customer pays immediately upon delivery of the goods contributing to your cash sales. The second customer takes a line of credit and pays you 60 days after the invoice is sent. This contributes to your accounts receivable. In both cases, you have collected cash from customers; while the method might differ, both constitute cash collections. 

What Is the Importance of Cash Collections

Cash drives business functions; therefore, collecting the money owed to your company for goods and services provided is essential for various reasons.

  1. The entire business function of a company relies on the inflow of cash in return for the goods or services provided. Therefore, cash collection is the most important process in ensuring business stability and health. 
  2. Cash collections help ensure a steady cash flow for your company so that it can run its operations smoothly, cater to regular expenses, and meet financial obligations like bills, maintenance, inventory, payroll, loans, etc. 
  3. When you have received the money your business is owed, you will have the funds to invest in growth opportunities and innovation like product development, acquisitions, expansion, and much more. 
  4. Understanding your cash position through cash collections can also help you plan for the future, set appropriate goals, and allocate resources effectively.

How to Calculate Cash Collections from Accounts Receivable?

If you know your expected cash collections, then you can predict your company’s cash position and financial situation in advance. But how do you calculate this? To calculate cash collections you have to dd your cash sales to the estimated AR collections you think will be collectible.

Cash Collections Formula

Let us begin by letting you know that the number you arrive at with this calculation is an estimate and not definite. The actual numbers at the end of the year can be different based on delinquencies and late payments. Now let’s understand the expected cash collections formula and how to find cash collections. 

1 – Establish your estimated cash sales

You can arrive at a number for this based on your historical data on cash sales from previous years and your current year sales trends. 

2 – Calculate your estimated cash collections from accounts receivable

From your total accounts receivable, deduct what you estimate to be uncollectible receivables. By doing this, you will then arrive at the estimated collectible accounts receivable.

So, how do you calculate the estimated uncollectible receivables?

For this, you need to segregate your receivables into different aging buckets like 30 days, 60 days, 90 days, and over 90 days and create an accounts receivable aging report by analyzing your customer average payment history. This will give you an estimated collection rate for each bucket. Now, you must multiply your collection rate for each bucket with the receivables balance from each bucket. 

3 – Calculate your estimated cash collections

Let’s come back to our basic cash collections formula – 

Cash Collections = Cash Sales + Estimated AR Collections

To arrive at your final estimated cash collection number all you need to do is add the estimated open receivable numbers from each aging bucket to your estimated cash sales. 

Voila! You now have your total estimated cash collections.

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8 Methods of Cash Collection

We have come a long way since the days of silver and gold as currency. Today, paying your debts in physical cash is not your only option. Let’s explore some ways in which cash collections and payments take place.

  • Physical cash – Here, businesses pay for their goods with physical cash. However, this is not very widely used anymore as distances pose a barrier.
  • Checks and money orders – Customers can choose to pay with paper checks, money orders, or even e-checks, which the vendor must deposit into their bank. 
  • Credit cards – Businesses can also pay via credit card, where the money is transferred from the credit card account to the vendor account, and they can pay the credit card bill later. 
  • Debit cards – Here, the money is deducted from the customer’s bank account into the vendor account immediately. 
  • Electronic funds transfer (EFT) – Customers can authorize payment transfers from their bank accounts to the vendor accounts electronically through ACH transfers, wire transfers, and online bank transfers. 
  • Online payment platforms – Customers can use online payment platforms to make payments through payment gateways or digital wallets like PayPal.
  • Automatic payments – When businesses have regular customers with fixed purchases, they can set up automatic payment and billing plans to make the process effortless. 
  • Other methods – In cases where the vendor is unable to collect payments, they might hire collections agencies to get the payments or offer installment plans. 

10 Steps of the Cash Collections Process for Accounts Receivable

How you go about your cash collections depends entirely on your business and its strategy; however, we can take you through the basic common steps required to collect cash from accounts receivable. 

Cash Collection Process

Step 1 – Generate invoices: This is where the process begins. You first have to create an invoice for the goods or services that you have delivered to your customer. This invoice will have information like the amount owed, payment terms, and payment due date. 

Step 2 – Send the invoices: Next, you need to ensure your customer receives the invoice by sending it to them via email, post, or through an online portal if you have one. 

Step 3 – Send out reminders: A healthy collections practice is to send your customers payment reminders just before the due date, on the due date, and after the due date in case they have not paid. This can be done via emails and post. 

Step 4 – Late payment communication: If they haven’t paid past their due date, you need to enhance your collection strategy. Open up a line of communication with them via email or even call to understand why the payment has not been made. Offer incentives or installment plans if they are struggling to make the payment. This is where the negotiation strategies are essential.

Step 5 – Process the payments: When the customer finally makes the payment, you need to process them based on the method of payment. 

Step 6 – Accounts reconciliation: Once the payment has been processed, you need to reconcile the payments with the respective invoices and accounts receivables. This process can be quite tedious and can be automated with a good cash application software. 

Step 7 – Record transactions: After you reconcile the payments, you need to record the transactions in your accounting books or software for an accurate depiction of your finances.

Step 8 – Deposit funds: If you get paid in cash or checks, you need to deposit them into your company account to be available for use.

Step 9 – Handle adjustments: Often, you will encounter issues with discounts, overpayments, returns, etc. You need to properly evaluate these discrepancies in payment and make adjustments to avoid negative accounts receivable balances and other issues.

Step 10 – Conduct analysis and create reports: At the end of the day, you need to analyze your data to discover payment trends, customer behavior, and your current financial situation. This helps with making decisions and strategies for the future. 

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What Are the Challenges of Cash Collections

Cash collection can be a strenuous process involving many complicated and time-consuming challenges. However, today, there are numerous ways in which these challenges can be tackled. Let’s explore some.

Late payments 

Problem – Late payments have almost become a trend today in B2B trade. If customers pay late or past due, your business might face severe cash flow problems and delayed growth. 

Solution – Equip yourself with better debt collection strategies to improve your collections, like payment plans, early payment incentives, and discounts. It is important to also improve your collections team’s negotiation skills so they can find solutions that work best for your business as well as your customers. Lastly, consider adopting an AI-powered collections management software to supercharge your collections.

Bankrupt or delinquent customers 

Problem – Sometimes, your customers might go bankrupt or be unable to pay back the debt they own. This can lead to a loss of revenue or expensive, time-consuming efforts to retrieve the money through legal actions. 

Solution – To avoid such cases it is important that you assess a customer’s financial situation and risk factors before even extending a line of credit. You need to carefully evaluate their credit score and assign a credit limit. Additionally, you need to regularly run credit and background checks on existing customers to ensure there are no additional risk factors. All of this can be done with the help of good credit management software

Invoice disputes

Problem – In trade, there are bound to be disputes. At the time of payment, customers might raise disputes related to returns, discounts, invoice errors, etc. In these cases, you have to address these disputes as fast as possible to get paid. 

Solution – Invoice disputes can severely delay payments from customers. However, with AI-driven dispute management systems, you can predict disputes in advance using historical data, automate the process to check for validity of disputes instead of spending hours on it, and even auto-code your disputes and deductions. 

Payment fraud

Problem – In recent times, big companies have been hacked and frauded. This can sometimes occur with payment methods like counterfeit checks, fake card details, and fraudulent bank transfers. 

Solution – To safeguard your company from this, you need to incorporate strong security measures and proper reconciliation techniques. However, this can be quite time-consuming; you can, therefore, incorporate a cash application management tool that will do the heavy lifting for you in seconds.

Lack of communication with customers

Problem – In any relationship, communication is key. If you do not have open and regular communication with your customers it can lead to late payments, disputes, and misunderstandings. 

Solution – Ensure that you are encouraging open and transparent communication channels with your customers. This can take up a lot of time and human resources but can be tackled by adopting a comprehensive order-to-cash management system that will automate a majority of your communications. 

Payment processing

Problem – When receiving cash collections from many different modes of payment, reconciling them can be complicated and very time-consuming. Additionally, you can have issues with not having the payment option that is convenient to your customer or expensive processing costs.

Solution – Having your own B2B payments suite can give you your own payment portal so customers can use the most convenient payment mode, minimize surcharge costs, and manage surcharges.

How Can HighRadius Help?

We are at the forefront of bringing automation and AI to businesses’ financial management. Now that we have understood how important cash collections are to your business functioning, it is important to focus on how you can scale up your collections processes to optimize your revenue. 

HighRadius Collections Management Software is a comprehensive tool that is powered by AI and automation. It can increase your collector efficiency by 30% and reduce your past due by 20%. It provides features like creating an AI-prioritized worklist that uses 20+ variables and historical data to establish which customers need to be contacted and addressed and to what extent. Some of the other features include in-app dialers, intelligent email inboxes, automated dunning, generative AI to assist with drafting communications, activity tracking and logging, in-app payment acceptance, dispute management, and with much more. 

If you are ready to bring your business to the future, then it’s time to embrace AI in your collections.

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FAQs

1) How do you solve cash collections?

To solve the issues with your cash collections, consider streamlining your invoicing, offering incentives and discounts, clarifying payment terms, and rigorously following up on overdue invoices. Enhancing your negotiation skills and adopting AI and automation can greatly help with this. 

2) What are expected cash collections?

Expected cash collections refer to the total amount of payments that you estimate will be collectible from customers. This can be through cash sales, accounts receivable, or other sources of revenue. 

Use this formula to calculate it – Estimated Cash Collections = Cash Sales + Estimated AR Collection

3) What is an example of a cash collection?

An example of cash collection is when a customer orders goods or services from you and pays you upon the delivery of the goods. This is known as cash sales. If taken on credit, then the customer will pay on the agreed-upon due date. Both of these are examples of cash collections. 

4) What is a cash collection schedule?

A cash collection schedule is created to understand when payments are expected from customers who owe money during a specific period based on the agreed-upon due dates. It consists of the date and time frame for receiving payments and helps businesses forecast their cash position. 

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