Accounts Receivable 101​

What is Accounts Receivable, and why does it matter?

A recent survey conducted by PYMNTS, one of the leading publications tracking news and trends in the payments industry, found that nearly 93 percent of SMBs are digitizing their accounts receivable and accounts payable systems. If that wasn’t indicative enough of the interest in changing outdated and inefficient processes, another 3 percent plan to digitize within the next 12 months. This means that practically everyone surveyed is focused on digitizing their AR/AP. But what is accounts receivable, and why does it matter?

Simply put, “Accounts Receivable” is money owed to a business by its clients or customers. It is listed on a balance sheet as its own line item under the assets section because its money your business is due. This is not to be confused with “Accounts Payable,” which is the amount of money your business owes someone else.

Accounts payable shows up as a liability on your balance sheet. But for now, we’re going to focus on accounts receivable, also known as AR.

Let’s consider an example. You own a bakery that supplies muffins to a chain of gourmet coffee shops. Each week they order 1,000 muffins at a cost of $1/muffin. Assuming four weeks in a month, this means that by the end of the month, the coffee chain owes you $4,000. Because they’re not paying for these muffins immediately (likely a 30-, 60- or 90-day term, something we’ll discuss in just a moment), this $4,000 is considered accounts receivable on your balance sheet.

Once you get paid, this money moves from the AR line to “Cash” within the balance sheet’s assets section. It’s important to know what your accounts receivables are for a range of reasons including understanding your ability to expand, meet payroll, pay your bills, weather unexpected market conditions and more.

One of the key things to be aware of when it comes to accounts receivable are the terms of payment. As mentioned in the example, when the coffee chain bought the muffins, they essentially provided an IOU for $4,000. But when can you expect to receive this money?
That’s where the payment terms come in.
When signing the contract, both parties will agree to payment terms, meaning how long until you get paid for goods or services provided. Each company and each relationship is different. But typically those payment terms will be either 15, 30, 60 or 90 days. That said, it’s not unheard of, although it’s rare, to have up to a 180-day payment cycle or even a 10-day cycle.

These terms are important to know because it’ll help you as a business owner understand your cashflow situation and adjust your spending accordingly.
But let’s say that 90 days passes by and you still haven’t gotten paid for the $4,000 in invoices the coffee chain owes you. Then what happens and how does that impact your accounts receivables?

While there is no standard answer for this, as each situation is different, there are procedures many businesses will employ to get the money they are due for invoices. Certainly most companies will make a phone call or an email inquiry and see if something just slid through the cracks. But if that’s not the case, and the customer still doesn’t pay the past due invoice(s), you can charge them late fees, hoping that will get them to pay. If that doesn’t work, you may want to find out what’s causing the delay and consider setting up a repayment program for the invoices owed that works for both of you. If none of this succeeds, and the customer refuses to pay for the work done, you may need to send the account to collections. Of course, if that money is considered uncollectable, you will need to write it off as uncollectable debt.

There’s a lot to consider when it comes to accounts receivables, especially when it comes to being a small business owner. You spend so much time focusing on running and growing your business that AR may not always be top of mind. But it’s best to have a reliable system in place to help ensure you get paid by your partners when you should. This could take the form of having dedicated staff, working with a technology partner or otherwise. This will allow you to focus on making your business the best it can be.