Why do companies have accounts receivable?
Companies use accounts receivable to offer credit to their customers, facilitating sales and building strong customer relationships. Allowing customers to pay later enables businesses to expand their client base and attract larger contracts. Moreover, accounts receivable improves customer convenience, increases trust, and ensures consistent working capital inflow. Managing AR efficiently reduces payment delays, supports operational needs, and contributes to business growth by maintaining reliable revenue streams.
What is included in accounts receivable?
Accounts receivable comprises unpaid invoices and balances due from customers for products or services already provided. It includes credit sales, instalment payments, and any receivables agreed under credit terms. This asset plays a vital role in tracking and managing a company’s revenue cycle. Additional items include trade receivables, customer refunds, and adjustments. Accurate recording ensures proper cash flow management, aids in financial planning, and strengthens the company’s working capital management.
How does accounts receivable work?
Accounts receivable involves tracking and collecting payments due from customers. Below is the step-by-step process:
- Invoice generation: Businesses send invoices to customers post-delivery
- Payment terms: Clear credit terms and due dates are established
- Payment follow-up: Regular reminders are sent to ensure timely payments
- Receipts tracking: Payments received are recorded against invoices
- Reconciliation: AR accounts are reconciled to prevent discrepancies
Efficient AR management ensures smooth operations and maintains working capital.
Risks of outstanding accounts receivable balances
Outstanding accounts receivable balances can pose significant risks to a business’s financial health. These risks highlight the importance of timely collections and proactive management:
- Cash flow issues: Delays in payments can disrupt a business’s ability to cover operational expenses
- Bad debts: Long overdue balances increase the likelihood of non-payment, leading to financial losses
- Increased costs: Additional resources may be required for follow-ups, legal actions, or collections, escalating operational costs
- Reduced liquidity: High outstanding AR impacts liquidity, making it difficult to invest in growth or meet financial obligations
By managing AR efficiently, businesses can mitigate these risks and maintain a stable financial position.
Benefits of accounts receivable (AR)
Accounts receivable management offers numerous advantages, helping businesses maintain financial health and foster growth. Below are the primary benefits:
- Enhanced sales: Extending credit to customers increases sales opportunities, attracting a larger customer base
- Stronger relationships: Providing credit options builds trust and improves customer loyalty
- Revenue stability: Timely AR collections ensure regular cash inflow, supporting operational needs
- Financial flexibility: Steady cash flow through AR management allows businesses to invest in growth and handle unexpected expenses
Efficient AR processes are critical for long-term sustainability and financial planning.
Examples of accounts receivable (AR)
Accounts receivable comes in many forms, depending on the nature of the business and its operations. Here are some common examples:
- Unpaid invoices: For example, when a manufacturer delivers goods to a retailer with payment due in 30 days, the amount owed is recorded as accounts receivable until the retailer settles the bill.
- Utility bills: Utilities such as electricity, water, or gas are often billed after usage. The unpaid amount is treated as accounts receivable until the customer pays.
- Subscription fees: Companies offering software, gyms, or other subscription-based services record outstanding monthly or annual fees as accounts receivable until collected.
- Professional services: Law firms, marketing agencies, or construction companies that invoice clients after completing a project or milestone list the pending payments as accounts receivable.
- Credit card sales: When a customer pays with a credit card, the retailer records the amount due from the credit card company as accounts receivable until the funds are transferred to the store’s account.
- Rental income: Property management companies treat unpaid monthly rent from tenants as accounts receivable.
These examples highlight how accounts receivable plays a critical role in managing cash flow and maintaining operational continuity.
Process of accounts receivable
The process of accounts receivable involves several steps to ensure effective tracking and collection of payments. Here is an overview:
- Customer onboarding: Set up credit accounts for customers, ensuring clear communication about credit terms and payment policies
- Credit approval: Evaluate customers’ financial stability and creditworthiness before extending credit
- Invoicing: Issue accurate and timely invoices immediately after delivering goods or services
- Payment collection: Follow up with customers to ensure payments are made within the agreed timeframe
By implementing a robust AR process, businesses can streamline collections and minimise payment delays.
Impact of accounts receivables on financial statements
Accounts receivables significantly impact a company’s financial statements and key financial indicators. Below are the primary effects:
- Asset value: AR is recorded as a current asset on the balance sheet, indicating expected cash inflow
- Revenue recognition: AR reflects earned revenue, even if cash is not yet received
- Profitability: Delays in payments can reduce net profits and create financial strain
- Cash flow: Proper AR management ensures a steady flow of funds, supporting daily operations and working capital
Efficient AR management enhances overall financial transparency and stability, allowing businesses to make informed decisions.
Accounts receivable vs. Accounts payable
Understanding the difference between accounts receivable (AR) and accounts payable (AP) is crucial for managing business finances effectively. Below are the key distinctions:
Feature
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Accounts Receivable (AR)
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Accounts Payable (AP)
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Definition
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Money owed to the business by customers.
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Money the business owes to suppliers or vendors.
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Balance Sheet
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Shown as a current asset.
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Shown as a current liability.
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Cash Flow Impact
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Leads to future cash inflow.
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Represents future cash outflow.
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Transaction Role
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Records a sale made on credit by the seller.
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Records a purchase made on credit by the buyer.
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Invoicing
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The AR team issues invoices to customers.
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The AP team receives invoices from suppliers.
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A balanced approach to managing AR and AP ensures financial stability and smooth business operations.
Conclusion
Accounts receivable is an integral part of any business’s financial management. It not only supports stable working capital but also ensures a consistent flow of funds necessary for day-to-day operations. By efficiently managing AR, businesses can minimise risks such as bad debts, enhance profitability, and strengthen their financial position. Bajaj Finance offers tailored solutions for optimising AR processes, helping businesses streamline collections and improve cash flow. Additionally, effective AR management enhances eligibility for a business loan, empowering companies to fund growth and achieve long-term success.
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