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What is Accounts Receivable?

As a small business owner or solopreneur, there's always a lot to learn. From marketing to customer service to accounting, you have to juggle many tasks and responsibilities. You might also find that you're continuously hearing new terms, such as accounts receivable.

If you're not familiar with accounts receivable, it refers to the money your customers owe for goods or services they have purchased on credit.

This article explains how the accounts receivable process works, and the steps you can take to implement or improve your accounts receivable process.

What is accounts receivable?

You can think of accounts receivable as an IOU list showing how much money your customers owe you for goods or services they've received. An invoice is considered an accounts receivable until it's paid. Managing your accounts receivable helps you track how much money you can expect in the future and ensures you get paid.

Many larger companies have entire accounts receivable departments in charge of billing. As a small business owner, you might take care of this on your own with the help of a spreadsheet or accounting software.

Is accounts receivable an asset?

Accounts receivable is listed as an asset on your balance sheet because it's money that your business will receive in the future. Once your invoice is paid, it's no longer considered an asset. If an invoice is never paid, you can write it off as bad debt.

What is bad debt?

Bad debt is debt that is owed to you but that goes unpaid, despite your best efforts to collect it. According to the Canada Revenue Agency, you can generally deduct bad debt from your taxes if you meet the following conditions:

  • You determine that an account receivable is a bad debt in the year.
  • You have already included the account receivable in income.

How accounts receivable can impact your business

Your business needs money to function and grow. Without money coming in, it can impair your ability to pay your bills or employees. This is why it's so important to have a defined accounts receivable process to stay on top of what you are owed.

How does the accounts receivable process work?

If you're wondering how the accounts receivable process works, consider the following steps:

Making a sale. You provide a service to a client or make a sale.

Invoicing. After making a sale, you create an invoice detailing the good or service, the price, and payment terms (for example, must be paid within 30 days).

Tracking. You can use a spreadsheet or accounting solutions to keep track of your sent, overdue, and paid invoices. This helps ensure payments don't get lost or forgotten.

Sending reminders. If you have an overdue invoice, you can send reminders to encourage prompt payment. You can do this manually or automate the process with online accounting tools.

Collecting payment. Once you receive payment, you can reconcile your accounts to ensure there are no discrepancies, and then close paid transactions.

Creating payment terms for accounts receivable

To help manage your accounts receivable and prevent a backlog of unpaid invoices, it helps to create clear payment terms outlining deadlines and penalties for overdue invoices. When creating payment terms, consider:

  • When do you want to get paid? Set a deadline for when you expect to receive payment. The most common payment term is net 30, which means your customer should pay you in full within 30 days of receiving your invoice. Larger businesses often have payment deadlines of net 60 or net 90, but you'll have to consider how quickly your business needs cash flow.
  • Will you offer discounts for faster payment? To encourage customers to pay their invoices early and improve cash flow for your business, you can offer a discount for quick payment. For instance, you might give clients a 5% discount if they pay within 15 days.
  • What is the penalty for a late payment? Consider if you want to include a reasonable late payment for overdue invoices. The goal is to encourage clients to pay on time to avoid the late fee. To maintain a good relationship with your customers, you can reach out and send a reminder to your clients before implementing a late charge.

Tips to improve your accounts receivable process

  • Send prompt invoices.
  • Review your accounts receivable regularly.
  • Follow up on unpaid invoices.
  • Consider providing discounts for early payments.
  • Use an accounting and invoicing program to send and track invoices and accept online payments.

Accounts Receivable Example

Company bookkeeping may require your firm to post dozens of receivable transactions each week. You need a clearly stated process to post accurate data.

Here’s a receivable example: You manage a tree service company, and you bill customer Smith $500 for removing a tree on March 25th. The customer does not pay immediately. Here’s the journal entry to record the sale in general ledger:

(To record tree removal revenue and to increase accounts receivable)

Both accounts receivable and revenue are increased.

When Smith pays the invoice April 6th, your tree service company posts this journal entry:

(To remove the accounts receivable balance and to record the cash payment)

The cash is received in April, but the revenue is correctly recorded in March. Using accounts receivable posts the revenue in the month earned, and your accounting records are consistent with the accrual basis.

Liquidity is defined as the ability to generate sufficient current assets to pay current liabilities, such as accounts payable and payroll liabilities. If you can’t generate enough current assets, you may need to borrow money to fund your business operations.

How accounting tools can help with accounts receivable

Small businesses that don't closely monitor accounts receivable might struggle to generate sufficient cash flow to maintain operations. Online accounting tools like QuickBooks Online can help you optimize your accounts receivable process by tracking your invoices, sending automated late payment reminders, and generating reports to help you stay on top of your cash flow. Learn more and start tracking your accounts receivable with QuickBooks today.

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