Accounts receivable is a term that is often thrown around by accountants. The term goes hand in hand with other terminologies such as invoices, collection processes, and revenue. If you’re wondering what accounts receivables are and why they’re so important, you’ve come to the right place. In this article, we will explore what accounts receivables are, why they’re important, and how you can manage them as a business owner.
What Are Accounts Receivables?
Accounts receivable is the sum of money that customers owe a business for products or services that were provided in the past. Accounts receivables are considered to be an asset because it is money that will be received by the business in the future.
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Why Is It Important to Manage Your Accounts Receivables?
Accounts receivables exist because a business extended a product or service on credit. This means that the client agreed to pay for the product or service in the future. However, sometimes accounts receivables are difficult to collect for an array of reasons. Sometimes it’s as simple as the client is having cash flow problems, other times its because the customer doesn’t want to pay.
Regardless of the reason, when a business doesn’t collect their accounts receivables, they’re providing a product or service for free. You may be wondering, why would a business provide a product or service on credit with the risk of not being able to collect the money? The answer is, it’s convenient for the client which improves the level of service you’re providing.
Instead of avoiding using credit entirely, most businesses actively manage their accounts receivables. This means reviewing what’s currently owed, assessing how overdue an owed amount is and communicating with clients to collect payment. The main reason why this is so important is because your cash flow will be impacted if you don’t collect fees for products and services provided. Essentially, you’ll be paying money to provide the product or service with no profit.
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Helpful Measures When Managing Your Accounts Receivables
There are various ratios from the world of accounting that are used to manage accounts receivable. There are three main ratios used to analyze accounts receivable. They are listed below, along with what the ratio communicates.
- Average Receivables Turnover Ratio (Net Credit Sales / Average Accounts Receivables). Communicates how many times a company collected their average accounts receivables over a certain period of time. The higher this number is, the better because it means the business has collected their average debt quickly.
- Average Number Of Days To Collect (365 Days / Accounts Receivable Turnover Ratio). Communicates the number of days between when a credit sale was completed and when the money was received from the customer. The shorter this period is, the better a business is at collecting debt.
- Receivable-To-Sales Ratio (Accounts Receivables / Sales). Communicates business liquidity and measures how much of a company’s sales happened using credit. A high ratio indicates short term cash flow problems because the credit sales may not be collected quickly enough.
How To Analyze And Manage Your Accounts Receivables
There are several tricks and tools you can use to effectively analyze your accounts receivables. The larger volume of sales you have, the more important it is that you stay on top of your accounts receivables. Let’s explore these tricks and tools below.
- Automation. If you have an accounting system that automatically sends out invoices and tells you when a payment is missed, it will be easier for you to manage.
- Policies and Procedures. Many companies have policies around debt collection. For example, when an invoice is 90 days overdue, it’s sent into collections. Or, payment reminders are sent every Friday for overdue invoices. Whatever suits your business best, make a clear policy to stay on top of your accounts receivables.
- Use Ratios. By using the ratios listed above, you’ll be able to assess how effective you are at collecting accounts receivables. If you’re not doing great, it’s time to make some changes.
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How Accounts Receivables Can Impact Different Parts Of A Business
As mentioned, a lack of accounts receivable collections impacts cash flow. Without money coming in, you will eventually run out of cash to pay bills and employees among other expenses. When you start defaulting on payments, your business can only operate for so long.
Money Is The Bloodline Of Business
Money truly is the bloodline of a business. Without it, you can’t pay for employee’s time, buy the raw materials you need or pay for your facilities. For these reasons, it’s important to stay on top of your accounts receivables so you don’t run into other issues.
