What Are Accounts Receivable and What Does It Impact
Abbreviated as A/R, Accounts Receivable is an accounting term for the money that the customers owed you in exchange for goods and services on credit. Accounts receivable consist of all unpaid invoices and are recorded under Current Asset in the Balance Sheet. If the business has to wait more than one year to convert AR to cash, it is considered a Non-Current Asset (long-term asset).
Your customers are expected to pay the invoice on or before the agreed due date.
Having a good understanding of the importance of accounts receivable is very crucial for maintaining the good financial health of your business. It is always recommended to have a healthy accounts receivable. Even if you have only a handful of customers but are bad at paying you on time, it still can hurt and affect your business in a bad way.
Each receivable has a term, which is the agreed period you have granted to the buyer for payment. Credit terms are normally 30, 60, 90 or 120 days, depending on the relationship with the customer and how big the order is. Any outstanding amounts your customers owe you remain as receivables – meaning you’re waiting to receive the cash from your customer. Unfortunately, not all receivables get paid on time. Some are never even paid at all due to lack of funds, bankruptcy and a myriad of other reasons. If you never expect to get paid, ultimately, you’ll have to write off this expected cash as a bad debt expense (it becomes an expense to you because you expected to be paid, but ultimately were unable to collect).
The way the accounts receivable works is that, first you sell your products and services to a customer, and then ultimately extend credit to them allowing them to pay you later. Sending an invoice comes next. Make sure all the significant details are on the invoice such as the correct product qty and amount, credit terms, customers details. Last comes the payment collection. Once your customer has received the invoice, they need to make payment according to the terms you’ve extended to them. A customer will hopefully make payment before the invoice due date, and when payment is received, you’ll provide them with a copy of their receipt.
It is also important to note that until your invoice is paid, the cash amount is considered an “accounts receivable”, once the amount is received and you have the cash in hand, it’s no longer a receivable.
Now let’s chat about how accounts receivables can impact your business.
If your accounts receivable increases (more and more customers owe you) but the time it’s taking you to get paid is longer than expected, this could impact your ability to pay your short-term debts.
Default and late payments from customers can lead to cash flow issues for any business. If your company has an accounts receivable balance, this means that portion of your revenue is still outstanding. Since accounts receivables are expected to generate cash inflow for your company, the longer the customer pays, the more it affects your future cash flow.
Accounts receivable not being paid on time can also have an impact on your team. A higher percentage of overdue receivables can distract staff from being productive due to constantly making follow up calls, sending emails to the customers. Increasing outstanding receivables can also increase a company’s loss due to having third party collection agencies. If their rate is higher than the amount being chased, just consider if it’s worth writing off the debts.
Accounts Receivable function is an important part of your small business. Always make sure that your receivables are being looked upon accurately and efficiently.