What is the accounts receivable process?

There’s nothing more exciting than receiving your first sale.

But don’t get complacent. You still have the task of chasing up that client for payment.

Your accounts receivable ledger is your point of reference, showing you exactly how much money should be coming in, and when.

However, it only works if you manage it correctly.

By following the right accounts receivable process, you can prevent potential cash flow headaches, ensuring that it’s never too long before your sales convert into actual cash in the bank.

In this article, we’ll walk you through each step, from creating accurate invoices to collecting payments on time.

Here’s what we cover:

The full accounts receivable cycle

The accounts receivable cycle plays an important role in keeping your business cash flow healthy. It determines how quickly you collect revenue from customers, making your cash flow more reliable. Accounts receivable is an asset on your balance sheet that can be quickly converted into cash.

This cycle involves more than just tracking who owes what. It’s a comprehensive process to ensure you get paid for the goods or services you provide.

It starts with generating an invoice and continues through collecting payment and reconciling your records.

A well-managed accounts receivable cycle means consistent revenue, allowing you to invest in growth and cover operational costs. Neglecting this process can lead to cash flow problems, which would negatively impact many other aspects of your business, including your ability to pay your own bills, invest in expansion, or even cover payroll.

Accounts receivable process steps

Let’s look at all the steps and counterparts involved in the process:

Step 1: Generating the invoice

Invoicing is the first step in getting payment from your customers after you accept their purchase request. Any errors here will trickle down through the whole accounting process.

Every invoice must include these key details:

• Your business’s contact information
• Customer’s details
• A unique invoice number for the transaction in question
• A clear description of the goods or services provided
• Quantity
• Price per unit
• Total amount due
• Payment terms.

Promptness in sending invoices soon after each sale is good practice because it encourages timely payment.

For a deeper dive into creating effective invoices, check out our guide on how to write an invoice.

Step 2: Delivering the invoice to customers

Invoices can be delivered in various ways, from traditional mail to email and through online portals.

Modern businesses often opt for digital delivery due to its speed and efficiency.

Automation can further streamline this process, particularly when sending invoices for recurring transactions or regular clients.

Automated systems can also track delivery, providing confirmation that the customer has received the invoice.

Step 3: Recording the transaction

Once the invoice is sent, your accounting system has to reflect this. If you’re sending invoices digitally, your system probably does this automatically, using the same information you used to make out the invoice.

However, if you do this manually, you have to be sure to input the invoice date, the amount owed, and the customer’s details.

This step ensures you have a clear picture of your outstanding receivables and helps you identify any potential payment issues.

Step 4: Collecting payment

Common payment terms include immediate payment or “Net 30” and “Net 60” agreements, which dictate the grace period (30 or 60 days) over which a customer can delay payment.

Payment methods include direct debit, online payment or card transactions.

Step 5: Reconciliation and matching

This final step involves comparing payments received with the corresponding invoices.

You may have heard of three-way matching, where a buyer checks that their order, delivery, and invoice all match.

For accounts receivable, all that’s necessary is two-way matching: the invoice you sent and the payment you received. This is because, as the seller, you are primarily concerned with confirming that the payment corresponds to the correct invoice and amount owed.

The reconciliation stage is also where you check whether any payments are still pending. Here, you decide whether you need to take further action, such as sending a follow-up email or making a phone call to inquire about the payment.

Accounts receivable flowchart

Let’s recap those steps with this accounts receivable process flowchart.

Best practices for an efficient accounts receivable process

To optimise your accounts receivable process, consider:

Automating invoices and reminders

Use automated systems to create invoices from sales or service records. This pulls customer and product/service information directly from your database, eliminating manual data entry, reducing errors, and saving time.

Once generated, invoices can be sent automatically via email or customer portals.

Additionally, your system can schedule automated reminders as payment deadlines approach, minimising late payments.

These reminders are helpful prompts that ensure customers maintain control over their outstanding balances and avoid unexpected debt. They also help your business maintain a healthy cash flow.

Setting clear credit policies

Define payment terms upfront when you receive the customer’s purchase order.

Before this, check your client’s credit payment history or creditworthiness, especially if it’s a new client. Be clear about deadlines, fees for late payment, and credit limits if your company offers credit terms.

This sets clear expectations for your customers and helps avoid disputes.

Offering multiple payment options

Cater to diverse customer preferences by offering various payment methods, such as credit cards, bank transfers, or online payment platforms.

This makes it easier for your contacts to pay promptly.

Regular reviews

Use your AR information to identify trends and potential issues early on.

Regular reporting on accounts receivable performance helps you identify which customers consistently pay on time and which ones may require more insistent treatment.

These reports also give you insights into your cash flow, indicating whether it’s at risk of deviating from your business plan or budget.

Typical KPIs to track are Days Sales Outstanding (DSO) and the Collections Effectiveness Index (CEI):

• Days Sales Outstanding measures the average number of days it takes your business to collect payment after a sale. Research similar businesses or niches to check DSO benchmarks so you know whether your figures are lower or higher than standard. The helps you assess the effectiveness of your collection efforts.
• Collections Effectiveness Index measures the percentage of receivables collected within a specific period. A high CEI indicates that your collection efforts are effective and helps you gauge the efficiency of your AR team. You may spot areas where you can optimise your processes to improve collections.

Recording transactions accurately and promptly

Log invoice details into your accounting system as soon as they are sent. This ensures a clear picture of outstanding receivables and helps identify potential payment issues.

How to overcome challenges with the accounts receivable process

Challenges in accounts receivable can stem from many issues. Here’s a selection of the most common hurdles and how to address them:

• Late payments: your customers may be going through financial difficulties, or they may simply experience administrative delays at their end. These are many causes that could lead to delayed payment. To overcome this, address any concerns promptly and in an approachable manner. You could also consider offering incentives for early payment. If late payments become a persistent issue, consider implementing stricter credit policies or working with a debt collection agency.
• Invoice disputes: these can arise from discrepancies in the goods or services provided, pricing errors, or misunderstandings about payment terms. Such impasses often result in partial payment of an order, known as a “short payment”. Address disputes in a professional manner, and as soon as possible. Be sure to provide clear documentation and aim for mutually agreeable solutions.
• Difficulty tracking receivables: as your business grows, you may find yourself tracking more and more invoices. The backlog of payments can become overwhelming, leading to errors and delays. Implement an automated accounting system to streamline tracking, generate reports, and send timely reminders.
• Bad debt: if late payment is not addressed, your customers may fail to pay their invoices altogether. To mitigate this risk, conduct thorough credit checks on new customers, establish clear credit limits, and regularly review customer payment history to identify potential issues early on. After exhausting all collection efforts, some debt may need to be written off as bad debt, and the timing for this varies by industry and company policy.

Strengthening your accounts receivable process for your business success

In essence, a well-managed accounts receivable process is one of several tasks that are necessary for maintaining optimal cash flow and ensuring your business’s financial stability.

We have highlighted how accounts receivable software improves processing speed and accuracy. However, it also helps you track which payments are pending and deal with potential problems before they arise.

On top of that, automation helps you scale processes to handle the load as your business grows.

Finally, a well-integrated AR and invoicing system enhances customer experience by offering partial access to clients, enabling them to view their invoice history, make payments, and flag potential discrepancies.