Accounts receivable: everything you need to know

As a business, you’ll sometimes have to allow your customers to make purchases on credit, which means that you won’t collect their payment automatically. This ensures that your customers have a little extra breathing room with which to pay, while giving you access to a wider client base. Accounts receivable is the process by which you collect these payments once they become due. Explore the accounts receivable process in greater depth with our comprehensive guide, right here.

What does 'accounts receivable' mean?

Accounts receivable refers to your company’s outstanding invoices, or in other words, the money that your company is owed by clients.

The term “accounts receivable” is a way of stating that these are “accounts” that your business has a right to “receive”, since you’ve already delivered a product or service and are now expecting payment. So, if your business sold a product or service for, say, £10,000, and gave a client a certain amount of time to repay the money they owe, then that £10,000 gets reported as accounts receivable on your balance sheet.

Why is managing your company’s accounts receivable important?

Properly managing your accounts receivable can have an enormous impact on your business’s bottom line. By closely monitoring the accounts receivable process and enforcing a formal collections policy, you can ensure that you’re generating enough cash inflows to remain operational. Many UK SMEs suffer from late payments, which means that a strong and effective accounts receivable team can often make the difference when it comes to your company’s financial health.

Of course, accounts receivable is important for a number of other factors. Firstly, accounts receivable can be used as a short-term financing solution if your business experiences cash flow problems. For example, you may be able to sell the outstanding invoices to a third-party for a small percentage of the original amount. This is referred to as invoice financing. Accounts receivable is also likely to be a matter of interest to potential investors or lenders, as it demonstrates how much money you’re expecting to make and how much capital is currently at your firm’s disposal.

How to improve the accounts receivable process

There are many different ways that your business can optimise your accounts receivable process, including offering positive incentives for early payers (and negative incentives for late payers), maintaining accurate customer data, keeping watertight credit policies, streamlining invoicing, introducing automation, and allowing your customers to pay via Direct Debit.

Is accounts receivable an asset?

Accounts receivable is marked as an asset on your company’s balance sheet. This is because it’s a representation of money that’s owed to you by customers. Later, once the receivables have been collected, accounts receivable will be converted to cash. Furthermore, accounts receivable is considered a current asset as it’s usually converted to cash within one year.

Accounts receivable vs. accounts payable

Accounts receivable and accounts payable are like two sides of the same coin. Whereas accounts receivable represents money that is owed to your business by customers, accounts payable represents money that your organisation owes to vendors and suppliers. In addition, accounts receivable is a current asset, whereas accounts payable is a current liability.

Accounts receivable turnover formula

The accounts receivable turnover ratio is used by businesses to measure the efficacy of their accounts receivable process. To work out your business’s accounts receivable turnover for yourself, simply divide your net credit sales by your average accounts receivable. A high figure indicates that your process is effective, and you have lots of reliable customers who are willing to pay their debts quickly.

Managing a credit balance in accounts receivable

If your business has a credit balance on your books, it means that a customer has paid you more than the amount stipulated on your invoice. This could be due to a range of factors, including duplicated payment or an error in the original invoice. To manage a credit balance, you’ll need to consult with your company’s accounts receivable credit balance policy. Usually, you can simply refund the difference or offer upgrades/add-ons to justify the additional payment.

Accounts receivable days formula

The accounts receivable days formula can help you work out how long your business needs to clear its accounts receivable, or the number of days required for an outstanding invoice to be settled. It’s one of the best ways to review the efficacy of your AR department. To work it out, you’ll simply need to divide your accounts receivable by revenue before multiplying by 365.

Check out our guide on the accounts receivable days formula

Accounts receivable and GoCardless

GoCardless can be a serious benefit to your accounts receivable team. By offering your customers the chance to pay with Direct Debit, you can totally automate the payment process. Because Direct Debit is pre-approved by customers, there’s never any need to chase up your accounts receivable as your business can take payment as soon as the invoice is ready.

We can help

GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.