Accounts Receivable: What Small Businesses Need to Know

Accounts receivable tells you how much of your cash flow is held up in unpaid client invoices. Here's how to manage it.

This guide was reviewed by a Business News Daily editor to ensure it provides comprehensive and accurate information to aid your buying decision.

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Accounts receivable management is an essential part of running a small business. Effectively, it can help you better understand and predict cash flow, improve customer collections, and make better credit extension decisions. Here’s what you need to know about managing your accounts receivable process.

What are accounts receivable?

“Accounts receivable,” or A/R, is the accounting term for money a business should receive from its customers from the sales of goods or services. It’s the amount of money for which you’ve created invoices but haven’t yet collected payment.

Accounts receivable funds are considered assets because they represent money the company has earned and expects to be paid for.

Example of accounts receivable

Most B2B billing hinges on accounts receivable, so standard invoicing practices make great examples of accounts receivable. If you bill a client hourly, invoicing that client every hour, day or even week would quickly become tedious for both parties. Instead, you would likely issue monthly invoices, expecting payment within 30 or 60 days. The total amount on your invoice, which represents a month’s worth of work, is included in accounts receivable.

Accounts receivable vs. accounts payable

When contrasting accounts payable vs. accounts receivable, accounts receivable is the amount of money you’re awaiting from client payments. In contrast, accounts payable represents the money you owe to your goods and services providers — the sum of all your vendor, third-party firm and supplier invoices.

To estimate whether you have enough cash coming in to pay your bills, compare your cash plus accounts receivable funds to your accounts payable expenditures. For example, say you have $10,000 in cash but owe $15,000 to suppliers within the next month. If you expect to receive $10,000 in payments from accounts receivable and other cash receipts, you should have no trouble paying bills.

However, if projected cash and cash receipts, including payments on accounts receivable, are less than your bills and expenses, you may have a cash flow problem.

The amount your business has in accounts receivable relates more to cash flow than to business profitability. While analyzing accounts receivable can help you predict cash flow, it's only one of many factors in determining whether your business is making a profit.

Why track accounts receivable?

Tracking accounts receivable may be a requirement. It is also a crucial tool for planning cash flow.

• Tracking accounts receivable may be required. If you use the accrual method of accounting, you are required to track accounts receivable and report income you’ve earned but haven’t yet received on your tax return.
• Tracking accounts receivable helps you plan cash flow. Tracking and analyzing accounts receivable is crucial for planning cash flow and ensuring you’re paid for the goods and services you sell. If you don’t track accounts receivable, you may forget to bill certain customers or not know whether you’ve been paid. You could end up providing your product for free, negatively impacting your profitability.

6 tips to help you stay on top of accounts receivable

It’s best to manage accounts receivable consistently and routinely. In retail, most transactions are paid for immediately. In other industries, customers may apply for a credit line and place orders against it. In these cases, you’ll provide an invoice and payment terms with the shipped product and the customer will pay you later.

Regardless of your system, ensuring payment is crucial. Here are six tips to ensure your business stays on top of accounts receivable:

1. Communicate with your clients.

Consistent communication with clients is key in managing your accounts receivable process. Invoices must be sent promptly, and your business accounting team must follow up appropriately with clients. Ensure all contact information is accurate and complete so your invoices are received by the appropriate party. Even a small typo in your invoicing information can cause extensive payment delays.

2. Create a robust internal accounts receivable process.

Create an accounts receivable process and stick to it. Select a day of the week to create, print and mail invoices. Choose another day to print an aged accounts receivable report and contact customers who are beyond their payment-term window. As your small business grows, you may need to split these tasks among different people to stay on top of all your accounts.

3. Confirm receipt of invoices.

Many companies have success when they contact the client to confirm receipt a week after sending an invoice for a significant purchase or service rendered. Things sometimes get lost in the mail or accidentally deleted in an email inbox. A quick inquiry about a bill’s receipt also provides you a chance to ask for feedback, demonstrating your excellent customer service skills.

4. Extend credit wisely.

Companies often receive payment for small purchases even before shipping an order or performing a service. However, this isn’t always possible with service-based companies or when selling high-cost goods. You may miss out on sales if you don’t offer credit.

If you decide to offer credit, ask your client to apply for a credit line. You should evaluate their payment ability and set a credit limit you’re comfortable with. Be sure both parties are clear on the payment terms and what happens if the account goes delinquent.

To develop a good credit policy, consider your customers' credit qualifications, keep them accountable and boost cash flow.

5. Document everything in the accounts receivable process.

Accounts receivable documentation helps the bookkeeping process by providing your accounting team with weekly or monthly inputs for financial statements. It is also a tremendous asset to your small business accountant at tax time.

Keep notes on order details, conversations and agreed-upon terms from the first contact with a client. In a worst-case scenario, that documentation may prove critical if you must pursue payment through a collection agency or court.

If you must pursue payment by hiring a collection agency, research and find a company that works with your business type and is familiar with your industry.

6. Write off uncollectible accounts.

If your accounts receivable balance grows over time and includes a high percentage of delinquent accounts, you should adjust accounts receivable by writing off bad accounts. Writing off bad accounts will help you accomplish the following:

• Accurately report business value: Your business assets are overstated if they include accounts you will never collect.
• Pay the correct tax amount: If you pay tax on income when it’s earned, not collected, you generally reduce your tax liability by writing off uncollectible accounts.
• Reduce future losses: Based on your analysis of uncollectible accounts, you may need to modify credit and collection policies.

Accounts receivable FAQs

What is the accounts receivable process?

1. The accounts receivable account is debited (increased) by the invoice amount, and revenue is credited (also increased) by the same amount.
2. When your client pays the invoice, the A/R account is debited, and the cash account is credited for the amount paid.

Is accounts receivable an asset or liability?

Accounts receivable funds are assets because you're owed the money in A/R, so it has a positive cash value. Assets are on the left side of the accounting equation:

Assets = Liabilities + Owner's Equity

Therefore, assets are a debit account.

What is cash flow, and how is it affected by accounts receivable?

Cash flow is a financial metric that helps you forecast whether your business will bring in enough cash to meet its financial obligations. Cash flow is related to income and expenses and includes both cash inflow and outflow. When analyzing accounts receivable, it's essential to look at the whole financial picture. For example, if accounts receivable are increasing because sales are up and adequate cash is coming into the business to sustain operations, the business should be fine. On the other hand, if total accounts receivables are up because customers are not paying what they owe, you may need to take action to avoid a cash flow crisis.

Should I include accounts receivable on my balance sheet?

If you use the accrual accounting system and recognize income when you earn it and expenses when you pay them, you'll likely include a line on your balance sheet for accounts receivable. However, many small businesses operate on a cash-basis accounting method. In this case, you should still track accounts receivable and manage the process appropriately. Keep in mind you won't include accounts receivable as an asset on your financial statements. Some small businesses use modified cash-basis accounting, under which they may include certain assets, such as accounts receivable, on their financial statements.

How do I enter changes to accounts receivable for accounting purposes?

Cash and accounts receivable are assets and, therefore, debit accounts. Sales revenue, on the other hand, is a credit account. When you extend credit to a customer making a purchase, you increase sales revenue by crediting it and increase accounts receivable by debiting it the same amount. When the customer pays the amount, you make a debit entry to accounts receivable. You also credit the cash account to reflect the increase in cash.

Should I include long-term contracts in accounts receivable?

Accounts receivable are current assets related to income already earned. If your business has long-term contracts, such as building construction projects, the entire amount is not included in accounts receivable immediately. Instead, you add amounts to accounts receivable as the work is done or as the customer receives goods and services.

What are the three classifications of receivables?

• Accounts receivable: Accounts receivable arise from the sale of goods or services.
• Notes receivables: Notes receivables pertain to debts, typically tied to formally signed instruments.
• Other receivables: Other receivables include interest, employee advances, shareholder or employee loans and tax refunds.

Best accounting software to track accounts receivable

Accounting software can help you create and send invoices, confirm their receipt, and follow up on late invoices. Choose accounting software that can help you organize and analyze your accounts receivable and make better business decisions based on your turnover ratio and other metrics.

The following are among the best business accounting software platforms that can help you handle accounts receivable more efficiently:

• QuickBooks Online: QuickBooks Online is a popular, widely used accounting software solution that can address the needs of businesses of all sizes. It’s easy to set up and integrates with numerous business software platforms, ensuring your systems work together cohesively. Our detailed QuickBooks Online review explains how this platform can help your business automate accounts payable and receivable processes.
• FreshBooks: FreshBooks is an intuitive accounting solution with robust invoicing features that can help you manage your receivables and monitor cash flow. Our comprehensive FreshBooks review explains this vendor’s affordable pricing structure, which starts at $19 monthly, and robust options for accounting reports.
• Plooto: Plooto has extensive automated accounts payable and receivable tools that can help you streamline your accounting processes and create custom workflows. Read our updated Plooto review for pricing information and details on this platform’s automated invoice management functions.
• Zoho Books: Zoho Books is an affordable, easy-to-use solution capable of automating numerous tasks on your accounting checklist, including accounts payable and receivable processes. As our Zoho Books review explains, this platform has a unique client portal. Its portal can help you improve communication and avoid misunderstandings.

Accounts receivable management is key to streamlined cash flow

By taking control of your accounts receivable process, you can determine how much your clients owe you and estimate when you should expect to receive payment. Better control of accounts receivable can also help you improve collections — or avoid extending credit to customers unlikely to pay. By improving your business cash flow, better accounts receivable control can mean the difference between your business struggling to pay bills and growing for years to come.

Marci Martin and Max Freedman contributed to this article.

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