The Accounts Receivable Process: Step-by-Step Guide [with Templates]

Introduction

In any business, a sale isn’t truly complete until the cash is in the bank. The crucial period between delivering a product and receiving payment is where many companies face their biggest financial challenges. Every dollar owed during this time for goods and services already delivered makes up a critical asset on your balance sheet, Accounts Receivable (AR).

However, accounts receivable isn’t merely a line item on your balance sheet; it has a direct impact on your cash flow, operational efficiency, and overall financial health. How you track, manage, and collect these outstanding payments can determine how quickly your business can reinvest, pay expenses, and grow.

Effectively tracking and managing accounts receivable is crucial for keeping cash flowing and running your business smoothly. In this blog, we will explore what is accounts receivable, why it matters, and practical ways to stay on top of it to keep your business running smoothly.

What is Accounts Receivable?

Accounts receivable refers to the outstanding invoices your company has, which represent the money owed to you by customers for goods or services that have been delivered but not yet paid for.

This means when a business delivers a product or service but allows the customer to pay later, the amount owed is recorded as accounts receivable. In other terms, the company extends credit to its customer, which usually comes with agreed-upon payment terms, often 30, 45, or 60 days, depending on the business and industry. During this period, the unpaid invoices are tracked as accounts receivable until the customer completes payment. It also represents the money that will flow into the business in the near future.

What is the Accounts Receivable Process?

The accounts receivable (AR) process is a structured sequence of actions that a company undertakes to invoice clients, monitor payments, and secure the collection of funds owed for goods or services provided.

This process is not a standalone activity; rather, serves as a vital link between sales and revenue, ensuring that business transactions are not merely initiated but also successfully concluded through timely payments. 

This conversion from sales to actual revenue is what keeps the business financially healthy and capable of growth. The below given image show a typical lifecycle of accounts receivable process.

Importance of Accounts Receivable

Accounts receivable is important because it reflects money that will come into the business in the near future. Having a clear record of what customers owe helps owners and managers understand how much cash is available to meet expenses and plan ahead. If receivables are not tracked well, it can create cash shortages even when sales look strong on paper.

It also plays a role in how outsiders view the business. Banks, lenders, and investors often check accounts receivable to see if a company collects payments on time and can manage credit responsibly. Common measures like receivable turnover or the average number of days it takes to get paid show how efficient a business is at turning sales into actual cash. These insights make accounts receivable not only an accounting entry but also a sign of financial discipline and reliability.

Difference between Accounts Receivable and Accounts payable?

Accounts receivable (AR) represents the money your business is owed by customers. It shows up when you deliver goods or services but allow clients to pay later. Until the payment is received, the pending amount is recorded as an asset on your balance sheet because it reflects future cash inflows.

Accounts payable (AP), on the other hand, represents what your business owes to suppliers or vendors. When you purchase goods or services on credit, the outstanding invoices become a liability on your balance sheet, since they are future cash outflows.

Example of Accounts Receivable

To understand accounts receivable better, let us look at a simple example.

Company A, the supplier, delivers office equipment to a client, Company B. Instead of asking for immediate payment, Company A issues an invoice with a 30 day credit period.

At the time of delivery, Company A records the value of that invoice under accounts receivable since the payment is still pending. Over the next 30 days, this amount remains in accounts receivable as an asset on Company A’s balance sheet.

Once Company B makes the payment within the agreed period, the pending receivable is cleared and the amount is recognized as actual revenue by Company A.

This cycle of delivering the product or service, issuing an invoice, recording it as receivable, and later collecting the payment shows how accounts receivable works in practice.

Accounts Receivable on the Balance Sheet

Financial statements show the actual state of accounts receivable through standardized accounting practices. The balance sheet displays accounts receivable as a key component that reveals crucial details about a company’s financial health.

How AR is recorded in accrual accounting

Accrual accounting records accounts receivable as a current asset on the balance sheet. This represents money customers owe to the company for goods or services delivered but not yet paid for. Revenue recognition happens at the time it is earned, whatever the timing of cash payment might be.

The standard journal entry to record accounts receivable has these steps:

1. Debiting accounts receivable (increasing this asset)
2. Crediting sales revenue (recognizing income earned)

To cite an instance, a business that invoices a customer for $500 would make this entry:

Payment receipt leads to another entry that completes the cycle:

Accounts receivable examples in financial statements

Accounts receivable directly affects a company’s liquidity position on the balance sheet. Here’s a simple example:

The original balance sheet shows accounts receivable of $100,000. Credit sales of $200,000 in April increase accounts receivable to $300,000. Collections of $100,000 in May reduce accounts receivable to $200,000.

Accounts receivable affects other financial statements too:

• Income Statement: Credit sales increase revenue; uncollectible amounts may become bad debt expenses.
• Cash Flow Statement: Changes in accounts receivable appear in the operating activities section and show collection efficiency

The 8 Accounts Receivable Process Steps

Below, we break down the process into 8 comprehensive steps, providing you with a roadmap for effective AR process management.

Step 1: Customer Order Placement

When a customer decides to make a purchase, they’ll typically send a purchase order. Upon approval, a sales order is generated, which serves as a binding agreement detailing the goods or services, their quantity, price, and other terms of the sale. Before proceeding, it’s crucial to assess the customer’s creditworthiness.

Step 2: Credit Approval

Before you even send out an invoice, it’s crucial to assess the creditworthiness of your customers. This is especially important when transactions often involve significant sums and extended payment terms.

A thorough credit application process is essential to assess the credit risk associated with each customer. Based on your company’s credit policy, you may approve or deny credit, or suggest alternative payment methods.

New Customers: 

Implement a credit application process that aligns with your company’s documented credit policy. This process may take a few days and should assess the customer’s financial stability and payment history.

Related Read: How to Assess the Creditworthiness of a New Customer: Step-by-step Guide

Existing Customers: 

Periodically review the credit terms for existing customers, especially if their order volume increases or their payment behavior changes. This ensures that you’re not exposing your business to unnecessary risk.

Step 3: Invoice Dispatch

An invoice serves as the definitive record of a customer’s purchase, outlining how much is owed and the payment due date. The quicker you can send out the invoice, the sooner your payment terms begin, so it’s beneficial to automate this step as much as possible.

Step 4: Collections Management

Late payments are an unfortunate reality. A structured collections process helps in following up with customers who have overdue invoices. The frequency and nature of these follow-ups can vary based on the customer’s payment history and the amount due.

Below are some time frames commonly used by companies for carrying out their collections outreach:

Step 5A: Writing Off Uncollectible Debts

When you’ve exhausted your outreach efforts (including passing off the debts to a collection agency or legal counsel) and determine the payment is uncollectible, you’ll write off the receivable as bad debt.

The timing for this can vary by industry and should be in line with your company’s financial policies. For some industries, like transportation services, for example, an average days sales outstanding (DSO) of above 50 days is normal. If late payments are common in your line of work, it makes sense to wait before writing off an invoice as bad debt.

Step 5B: Payment Processing

Business buyers pay their invoices in several ways, including:

1. ACH or EFT
2. Wire transfer
3. Debit, credit, or virtual card
4. Checks

Efficiently processing these payments is essential for accurate financial records.

Businesses that want to accept digital payments will need a payment processor, payment gateway, and at least one merchant account, not to mention a platform to support e-commerce or self-service customer payments. Some payment service providers will wrap all of this up into one offering.

Most B2B businesses still accept a significant volume of paper checks, with a recent survey by AFP pointing to 92% of organizations continuing to use checks for incoming payments. To support this, businesses will often resort to managing multiple lockboxes (where a bank receives and processes checks for you).

Note that although lockbox services eliminate the need for you to receive checks at your office, they don’t take away the effort involved in processing them. Going through lockbox files to apply payments to invoices still takes work.

Step 6: Cash Application

Once a payment is received, it needs to be posted to the corresponding invoice(s). This step can be complicated by factors like missing remittance advice or discrepancies between payment information and open invoices.

Related Watch: 3 Cash Application Best-Practices

Step 7: Dispute Resolution

Invoice disputes can delay payments significantly. If a customer raises an issue, it’s crucial to initiate the dispute resolution process promptly to prevent further delays and maintain good customer relations.

Customers will often pay the portion of their invoice that’s not in dispute (a short payment), which adds another layer of complexity for your AR team. They’ll have to confirm why the short payment happened, whether it was for a valid reason, and how to apply the payment in your accounting system.

Step 8: Reporting and Analytics

During the month-end close process, your finance team will check that they’ve recorded all transactions and put the closing balance of all general ledger accounts into a report (a trial balance). This allows you to put together financial statements for that period to report to the rest of the company.

Regular reporting on the status of your accounts receivable is crucial for financial planning and for assessing the effectiveness of your AR process. Metrics like Days Sales Outstanding (DSO) and Collections Effectiveness Index can provide valuable insights.

Key Performance Indicators for Successful Accounts Receivable Procedures

When it comes to evaluating the success of your accounts receivable process, it’s essential to focus on tangible business outcomes. These outcomes not only measure the efficiency of your AR operations but also directly impact your company’s bottom line. 

Here are the key performance indicators that signify a successful accounts receivable process:

Timely Invoicing

Prompt invoicing sets the stage for all subsequent steps in the AR process. It’s the starting point for payment terms and directly impacts how quickly you can collect payments.

Collections Efficiency Index (CEI)

A high CEI indicates that your collections team is effective in recovering receivables. It’s a crucial metric that directly correlates with your cash flow and liquidity.

Days Sales Outstanding (DSO)

A low DSO means that your company takes fewer days to collect payments from customers. This is a vital indicator of operational efficiency and cash flow management.

Reduction in Bad Debt

Minimizing bad debt shows your AR process is working. It means that your credit policies are effective and that you’re doing a good job of vetting customers’ creditworthiness.

Reduction in % AR Open

A lower percentage of accounts receivable remaining open indicates that more invoices are being settled, which in turn improves your cash flow and financial stability.

Accurate Record-Keeping (Cash Reconciliation)

Meticulous record-keeping is non-negotiable. Accurate and timely cash reconciliation is crucial for financial reporting and compliance. It also aids in dispute resolution and enhances customer satisfaction.

Automation and Scalability

As your business grows, your AR process should be able to scale with it. Automation tools can help in reducing manual errors, speeding up the invoicing process, and providing real-time analytics.

Traditional vs. Modern Accounts Receivable

The accounts receivable landscape has undergone significant changes over the years, particularly with the advent of automation technologies. While traditional methods have their merits, modern automation offers a plethora of advantages that can dramatically improve efficiency and accuracy.

Below, we compare the two approaches to highlight their differences:

How Automation Streamlines the Accounts Receivable Process

The advent of automation has revolutionized the accounts receivable landscape, offering a host of benefits that streamline operations, reduce errors, and enhance customer satisfaction. Here’s how automation is making a significant impact:

Faster Invoicing

Automation allows for the instant generation and dispatch of invoices as soon as an order is confirmed via their preferred method—be it email, EDI, or even traditional mail. This not only speeds up the invoicing process but also sets the stage for quicker payments.

Automated Collections

Gone are the days of manual follow-ups for overdue payments. Automation enables you to automate the entire collections management workflow, from segmenting customers and prioritizing accounts to auto-sending correspondences based on the payment terms, significantly reducing the time and effort involved in collections.

Real-Time Payment Processing

Automated payment gateways facilitate real-time payment processing, which means you get to update your records instantly and improve cash flow. It supports multiple payment methods, including ACH, wire transfers, and credit cards, providing both you and your customers with flexibility.

Accurate Record-Keeping

Automation ensures that all transactions are recorded accurately and in real-time. This is particularly beneficial for cash reconciliation, wherein it automatically matches payments to open invoices, even when remittance information is missing or incomplete. This ensures that your records are always accurate and up-to-date.

Advanced Reporting and Analytics

Automation provides advanced reporting features, including real-time analytics. With predictive analytics, you can forecast cash flows, analyze customer payment behavior, and even predict potential bad debt, enabling data-driven decision-making.

Better Customer Experience

Automation enhances the customer experience by offering self-service options and instant pre-built responses. Customers can view invoice statuses, make payments, and raise disputes or queries, all through automated customer portals.

Cost Savings

By reducing manual labor and errors, automation can result in significant cost savings. The initial investment in an automated system is often quickly offset by the long-term benefits.

Enhanced Scalability

As your business grows, automation allows your accounts receivable process to scale seamlessly. You can handle a larger volume of transactions without a proportional increase in manpower or resources.

Elevate Your Accounts Receivable Process Flow with HighRadius

In a tight economic landscape, optimizing your accounts receivable process cycle is essential. Reducing DSO improves liquidity and frees up capital for business growth.

Why Choose HighRadius for Your AR Transformation?

HighRadius’ accounts receivable software offers a robust set of solutions designed to streamline and accelerate each stage of the accounts receivable cycle. Here’s how we can make a difference:

A Unified, Cloud-Based AR Platform

What distinguishes HighRadius is our integrated receivables, a cloud-based platform. This unified solution enables customers to:

1. View invoices in real-time
2. Make secure payments
3. Engage directly with your team

The result? A streamlined accounts receivable process and an enhanced customer experience that fosters long-term relationships.

There’s much more to explore. Click here to learn more and dive deeper into how HighRadius can revolutionize your AR process.

Learn More about HighRadius’s Accounts Receivable Software

Lower DSO, boost working capital, and increase productivity with our AI-driven accounts receivable platform, integrated with modern ERPs.

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Accelerate payment recovery from delinquent customers and boost cash flow through automated collection workflows.

Cash App

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Credit

Mitigate credit risk, reduce bad debt, and streamline customer onboarding with AI-powered insights.

Deductions

Reduce Revenue Leakage with AI Prediction models that identify valid and invalid deductions.

FAQs

1. What is accounts receivable workflow?

An accounts receivable workflow outlines the steps for managing customer invoices from issuance to payment and reconciliation. It often includes invoicing, collections, payment processing, and cash application software.

2. What is an aging report in accounts receivable?

An aging report categorizes accounts receivable by the length of time an invoice has been outstanding. It helps businesses identify overdue accounts and assess the effectiveness of their collections process.

3. How do you calculate accounts receivable turnover?

Accounts receivable turnover is calculated by dividing the net credit sales by the average accounts receivable during a specific period. It measures how efficiently a business collects its receivables.

4. Why do we manage accounts receivable?

Managing accounts receivable is crucial for maintaining healthy cash flow, minimizing bad debts, and fostering positive customer relationships. It directly impacts a company’s liquidity and financial health.

5. What is the difference between accounts receivable and accounts payable?

Accounts receivable represents money owed to a business for goods or services sold. Accounts payable is money a business owes to suppliers for goods or services purchased.

6. How do you track or monitor accounts receivable?

Tracking accounts receivable often involves using specialized software to monitor invoice statuses, payment due dates, and collections efforts. Key metrics like DSO and aging reports are commonly used.

7. How can small businesses manage accounts receivable effectively?

Small businesses can manage accounts receivable by issuing invoices promptly, setting clear payment terms, actively pursuing collections, and regularly reviewing key performance metrics.