Introduction to Accounts Receivable

A man holding cash in his hand, symbolic of the relationship between accounts receivable and getting paid.

Accounts Receivable Basics

When your business starts out, you’re probably focused on expenses. Every penny going out the door (or your bank account) is money that you’ve invested or borrowed to start up your company. Once you’ve landed your first client, it’s essential to give your revenue just as much time and attention as you gave to those first expenses. (This is why our introduction to accounts receivable is key!)

For some businesses, you receive payment at the time of sale. A restaurant is paid at the end of a meal. A fast-food restaurant receives payments prior to the meal delivery.

But for many other types of businesses, you bill your clients after the services or goods have been delivered. This is especially true of projects that are billed hourly, where you may be able to estimate the amount of time a project will take but you cannot be sure of the final total until the project is complete.

Some businesses take several payments on invoices such as construction companies or manufacturers. They may take an initial deposit and several payments throughout the projects on a single invoice.

Keeping track of the amount you’ve billed your clients or customers is key to maintaining cash flow and ensuring that you get paid for the goods or services you are providing. (After all, getting paid is fairly important.)

What is Accounts Receivable?

Accounts Receivable is calculated as:

Accounts Receivable = Amounts Billed to Customers – Amounts Received

In other words, Accounts Receivable are the payment requests that you have sent out less the payments you received. Like a pirate that buried treasure with the intent of going back and collecting it later, every invoice is like a little bit of treasure that you intend to go back and retrieve.

Accounts Receivable is considered a current asset which means that you expect to receive payment on the invoices in less than a year.

Who needs Accounts Receivable?

Any business that does not receive payment before providing their service or immediately after needs to track their customer’s amount due. Even for businesses that use the cash basis of accounting for tax purposes, it’s essential to have an understanding of how much you expect to collect in the future to be able to project your cash flow. Additionally, businesses that need financing will often have to provide an accounting of account receivable to the financial institution to obtain a loan or line of credit. In some cases, it is possible to sell your Accounts Receivable balance to finance companies to fulfill an immediate need for cash. This is called factoring and usually carries a high imputed interest rate.

There are a few other concepts to understand when it comes to Accounts Receivable.

  • Invoice: A payment request sent by a provider for goods or services.
  • Net 30: When this appears on an invoice it means that payment is due 30 days after the invoice date. There are other common collection periods such as 45, 60, or 90.
  • Discount: Some invoices will include a discount if paid in full within a certain number of days otherwise the full invoiced amount is due.
  • Progress payments: These are payments made against an outstanding invoice that are not intended to cover the full amount of the invoice.
An hourglass symbolic of how you will have to wait to get paid if you have bad Accounts receivable.
A poor AR function will leave you waiting to get paid and short on cash. Be sure to get paid before the sand runs out!! (Or, if need be just flip over the timer and start again…)

What is the best way to monitor outstanding invoices?

When your business is small, you might be able to manage a handful of client invoices on your own without much thought. You’ll know who has paid you. A small business may be able to track invoices in Excel or a Google Sheet. But as your business grows, you may find yourself needing a more robust system for tracking invoices.

All significant accounting systems allow you to track customer invoices though some accounting systems, like QuickBooks Online, will require an upgraded subscription to activate this feature. No matter which system you use, you’ll want to track the date that the services or goods were provided, the customer name, the amount due, and any additional fees such as interest, late fees, or sales tax.

Once you’ve entered your invoices including the date that the invoice was sent to the client, you can run an Accounts Receivable aging report. The aging report shows you, by client, how long their invoices have been outstanding, usually grouped into 30-day increments. This helps you determine who needs to be contacted about outstanding bills.

How does thorough tracking of Accounts Receivable help your business?

If you have clients that are consistently behind on your invoices or do not pay them at all, you may want to reconsider them as a client or at least have a discussion with them about paying you in a timely manner.

Minimizing the time that invoices are outstanding creates a healthier cash flow for your business. If your clients are regularly behind on your invoices, you may want to consider accepting other types of payments including credit card payments to reduce the time it takes you to receive funds, even if you end up paying higher fees.

Billing is often the least fun aspect of owning a business and can often be overlooked or put off. By tracking your accounts payable, you can ensure that your clients are being billed regularly. No one likes a surprise bill years later, and those surprise late bills are much less likely to be paid.

Should you manage your AR yourself?

Early in your business’ life, you can probably monitor your Accounts Receivable yourself. As the number of clients grows, the amount of time it takes to input, review, and take action on your Accounts Receivable will also grow.

Many business owners find it uncomfortable to follow up with clients and ask for payments. While no one should feel awkward talking to a client about charges, it’s still fairly common. Outsourcing your accounts payable tracking and collection allows you to continue to focus on running your business while letting someone else deal with the headache of monitoring and collecting your payments. (Want to learn even more? Take a look at Deloitte’s write up on optimizing your AR function.)

Looking for a bookkeeping specialist to help with your accounts receivable or anything else related to your business? At My OC Bookkeeper we help companies all over Los Angeles, Orange County, Riverside, and San Diego with all things business. Whether you need help with bookkeeping, accounting, financial modeling, business plan development, CFO services, or anything in between, we are here to help. Reach out to us here.

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