Q&A: What Is Accounts Receivable and How Does It Work?
Updated May 3, 2023
If you work in sales, you may come across the term, "accounts receivable". Many companies have an accounts receivable department to track the money customers owe them. Understanding accounts receivable and how to implement it at your work can increase efficiency and allow you and your team to focus on providing excellent customer service. In this article, we answer the question, "What is accounts receivable?", explain how the process works, demonstrate how businesses use accounts receivable, and answer frequently asked questions you may have about the process.
What is accounts receivable?
Accounts receivable is the process of obtaining payment for services or goods. The term may also refer to the department in charge of billing. Within the field of accounting, the term “receivables” means that a business has made a sale, but hasn't received the proceeds from that sale yet. Many companies allow their customers to purchase products or services on credit. These credited items fall under the accounts receivable general heading. An example of accounts receivable is a utility company that bills you after the period you used their supply. All unpaid invoices sent to clients are accounts receivable.
The extension of credit to its customers by a business sets up the existence of an account receivable. Accounts receivable can constitute much of a company's assets that haven't yet materialized. It usually comes due within a year or less from the time that the client initiates the purchase. One way to think of an accounts receivable for a non-specialist is as a short-term IOU that the customer gives to the business. The IOU is valid for a period during which the customer must pay off the balance on the account. Failure to do so may result in default.
How a typical accounts receivable process works
Every business has its own process for maintaining its accounts receivable. Having an established process allows them to determine which payments are due, overdue, or paid. Larger companies may have an entire department dedicated to accounts receivable, while smaller ones may only have an accountant that handles all the finances. Regardless of the size of the company you work for, here are some ways you can set up a reliable accounts receivable process:
Developing credit practices
The accounts receivable process starts with onboarding a new client that can't or doesn't want to make their payment upfront. The business decides whether they are interested in offering the customer a line of credit. If they are, they prepare a document that outlines the terms and conditions for sale on credit. The company includes full disclosure of credit practices in this document to ensure customers understand everything they're agreeing to when signing the contract.
Then, a lawyer ensures that the document and agreement conform to all applicable national, provincial, and territorial laws. Terms and conditions tend to vary with the scale of the business as well. Larger firms offer longer periods for customers to repay their debt. Due to restricted cash flow from smaller firms, they tend to want to close their accounts receivable in a limited window and thus offer shorter payment periods.
Once the customer makes a purchase, the business creates an invoice for them. An invoice is a document that lists the items the customer purchased, the individual costs of each item, and the expected time for payment. Invoices usually have a unique number that the company can use for referencing or retrieval. While in the past, most invoices were physical, today's consumers typically have the option of a physical invoice or to go paperless with an e-invoice.
It's effective to send customers their invoices as soon as they enter into a purchase agreement with the company. The longer a customer takes to get an invoice, the longer they may take to pay it.
Tracking accounts receivable
The role of tracking the receivables from these credit payments falls to the accounts receivables officer. The accounts receivable officer enters the values for the purchase, updates the ledgers, and generates the invoice for the purchase. Additionally, with each payment, the accounts receivable officer updates the ledger to reflect the new amount they expect the client to pay.
Smaller companies tend to use professional accountants to operate their accounts receivable processes. They may not have enough funds to hire an accounts receivable officer as a stand-alone position. Larger companies sometimes have entire credit management facilities with accounts receivable officers assigned to areas, as opposed to individual clients. Additionally, larger companies can leverage sophisticated software and process automation.
Accounting for accounts receivable
The company's collections officer defines the due date for payments. Once the business manages to identify unpaid debts, the accounting department records the sales. The reconciliation of accounts includes accounting for unpaid debts, bad debts and early payment customers.
How businesses use accounts receivable
Accounts receivable is a flexible method for businesses to manage privileged clients. Occasionally, a business might consider selling a particular item to a client who isn't able to pay for that item as a single transaction. The business may decide to offer the customer a chance to pay for the item over a certain period, with the expectation that the customer will have to pay slightly more because of interest on the account. Businesses offer these methods of payments to clients because it allows them to close sales, even though it involves some risk.
Accounts receivable is a crucial part of measuring a company's liquidity. Valuators look at a company's history of accounts receivable to determine how much short-term assets the company can safely dedicate to the acquisition of stock or infrastructure. An accountant doing a fundamental analysis of a business would look at how often the business managed to collect on its accounts receivable balance. This is the business' accounts receivable turnover ratio. The more often the business managed to collect, the stronger the business' reputation would be.
Frequently asked questions about accounts receivable
To help you understand accounts receivable better, consider the following answers to these frequently asked questions:
What's the difference between accounts receivable and accounts payable?
Accounts payable is the amount a business owes to its supplies and vendors. When a company purchases items from a supplier or vendor on credit, the supplier or vendor creates and sends them an invoice. The company then pays this invoice within a specific time period. This means accounts payable is the opposite of accounts receivable. The term may also refer to the department that handles the invoices companies are receiving and processes the payments due.
Some companies merge the accounts receivable and accounts payable departments, while other companies have two separate departments to manage their finances. The main difference between accounts receivable and accounts payable is that accounts payable is a liability. It's a debt the company owes, while accounts receivable is an asset.
What duties do an accounts receivable employee have?
If you're considering working in accounts receivable, knowing more about the role can help you decide. Here are some of the duties you may have if you work in accounts receivable:
Create, process, and verify invoices for products or services the company sells
Help customers with any potential account discrepancies
Process and record customer transactions
Maintain organized records to keep track of payments and easily access customer accounts
Send bill reminders to customers when necessary
Work with accounts payable to keep the company's finances organized
Generate internal reports and financial statements
Regularly update job knowledge
What roles are available in accounts receivable?
Although smaller companies may only have one accounts receivable employee, larger ones tend to have a whole department. Here are some accounts receivable roles, their duties, and the average salary for you to consider:
Accounts receivable clerk: An accounts receivable clerk completes administrative tasks, such as creating invoices and updating customer accounts. Their national average salary is $45,372 per year.
Accounts receivable specialist: Accounts receivable specialists tend to work more with customers by addressing their concerns or reminding them of upcoming and overdue payments. Their national average salary is $47,934 per year.
Accounts receivable administrator: This is often another name for the accounts receivable clerk role. Their national average salary is $50,322 per year.
Accounts receivable manager: Accounts receivable managers create and update their team's processes to ensure everyone is working as efficiently as possible. Their national average salary is $73,787 per year.
Accounts receivable supervisor: Accounts receivable supervisors report to the manager and oversee the day-to-day activities of their team. Their national average salary is $63,936 per year.
Accounts receivable analyst: Accounts receivable analysts focus on outstanding debts by monitoring overdue accounts and following up with customers about their unresolved payments. Their national average salary is $46,238 per year.
Salary figures reflect data listed on the quoted websites at time of writing. Salaries may vary depending on the hiring organization and a candidate's experience, academic background, and location.
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