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Collecting Accounts Receivable: The Essential Guide

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A company must collect payments to ensure proper cash flow and revenue when selling goods or services on credit. Unfortunately, some businesses run into late payments or non-payment from clients.

Clients who don’t pay their invoices put a strain on the financial health of your business. Small business owners must ensure their accounts receivable collections are efficient, accurate, and reliable.

If you want to improve your business’s ability to collect on accounts receivable, we can help guide you with answers to these questions:

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    What is Accounts Receivable Management?

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    Accounts receivable management refers to handling invoices and collecting the money owed. Any business that sells on credit requires effective accounts receivable management to ensure cash flow.

    Selling on credit refers to a business providing goods or services to a customer or client with an agreement to pay at a later date. When a company sells on credit, it issues an invoice that acts as an IOU and records the transaction in the accounts receivable ledger.

    The invoice states what the payment is for, how much is due, and the due date. Invoices typically operate on a net 30 (due within 30 days) or a 90-day invoice cycle (payment is due within 90 days). However, some businesses use a 60 or 120-invoice cycle.

    The expectation is that the customer or client pays the invoice by the due. However, some companies go beyond the due date.

    An effective management process identifies late payments so you can prioritize collection. It also helps reduce late payments by alerting the business when a payment is coming due.

    What does Collecting on Accounts Receivable mean?

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    Accounts receivable collection is the most crucial aspect of managing the A/R process. Outstanding invoices represent money coming into your business.

    Any business that invoices clients and issues invoices must ensure it collects the money it’s owed. Failing to collect or allowing invoices to go unpaid beyond their due date creates massive cash flow issues and makes it difficult to plan for your business.

    Businesses use several collection methods for accounts receivable. Let’s look at different approaches to improving accounts receivable collection.

    How can I improve Accounts Receivable Collections?

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    Here are some solutions to help small business owners improve their company’s accounts receivable collection processes for better cash flow.

    Accounting Software

    One of the keys to staying current on accounts receivable is accurately recording transactions in your ledger. Manual processes are time-consuming, costly, and prone to errors. Using accounting software can help automate a consistent A/R process.

    Proactive Invoicing

    Part of ensuring collections is getting on the same page as your clients. When you first bring on the client, you want to ensure they understand credit policies, due dates, payment schedules, etc.

    It’s crucial to ensure you send accurate invoices as soon as you deliver the goods or services in the transaction. If a client continually falls behind on payments, you might need to re-engage them.

    Try reaching out to see why the client is late paying and what you can do to help ensure on-time payment in the future. Sometimes it just takes a couple of phone calls to get a business back on track.

    Aging Reports & Turnover Ratio

    An accounts receivable aging report organizes your outstanding invoices by due date and amount owed. It’s a convenient tool to prioritize collections according to the most urgent invoices.

    The accounts receivable turnover ratio is a metric that tracks a business’s efficiency in collecting outstanding invoices. The formula to calculate the turnover ratio is:

    Net Sales ÷ average accounts receivable balance = turnover ratio

    A higher ratio is better as it indicates the company is efficient at collecting on accounts receivable. Both the aging report and turnover ratio help identify problems for real-time intervention in collections.

    Act Quickly on Late Invoices

    It’s an unfortunate reality that the longer an invoice goes unpaid, the more unlikely a business is to receive payment. The quicker a business follows up on past-due invoices, the more likely it is to receive payment.

    Maintaining an aging schedule makes it easier for the company to identify past-due accounts, especially when they first become late. Some companies use automation to send instant payment reminders when an invoice is due and then again when it’s late.

    Make It Easier for Customers to Pay

    Giving your clients more ways to pay you leads to increased payments. Some companies use ACH payments to ensure payments are transferred in a timely manner.

    Other options include adding a card payment system and an online payment processor. Some small businesses utilize modern payment apps like CashApp for Business to process payments on the go.

    Early Payment Discounts

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    Offering a discount for early payment incentivizes clients to pay on time. For example, offering 2% off for payment in the first ten days of a 30-day invoice not only ensures on-time payment but helps improve cash flow with early payment.

    You can build the early payment discount into your pricing model to offset any revenue you lose with the discount. Also, since the money is coming in earlier, it might be worth taking a little off the top.

    Payment Plans

    Providing some payment flexibility encourages clients to pay when they experience financial distress. Maybe the client’s business missed its revenue quota and needs some help with paying accounts payable.

    Providing a payment plan is better than not receiving payment, and you help maintain that client relationship for when their business picks up again. Incorporating a payment plan with online tools helps you keep track of the payment status.

    Provide Financial Planning Advice

    Established businesses working with startups and young businesses should consider providing cash management services. As the senior business, you could provide webinars, training resources, and accounting tips to help newer businesses invest wisely. You want your clients to succeed, and aiding them helps ensure a long-term relationship.

    Review the Sales Process

    Another thing to consider is if there’s an issue with a company’s current sales process that leads to bad debt. Sometimes the sales team might extend credit to clients that are not creditworthy. Another issue is if the terms and conditions are unclear.

    Expand Your Customer Base

    When a business continually receives late payments, it could try expanding its customer base to include clients who pay on time or early. Larger clients and corporations tend to move slowly on paying invoices. Smaller, more agile companies might provide a nice counterbalance with early payments.

    Run Credit Checks

    Selling on credit requires a creditworthy client base. You want to avoid taking any unnecessary credit risks. Using a credit check service helps you identify if you should extend credit to a client and when it’s best to avoid it.

    Automate the Invoice Process

    Using an invoice automation service helps ensure clients receive their invoices on time. Most automation processes include payment reminders and past-due notices. It’s possible to get automation that connects to your accounting software.

    Frequently Asked Questions

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    Here are the most common questions about collecting on accounts receivable.

    What is the proper journal entry for Accounts Receivable Collection?

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    A business needs to track accounts receivable for accurate accounting and managing cash flow. An A/R transaction requires a minimum of two journal entries.

    The first entry occurs when the business delivers the goods or services the client purchases on credit. The company issues an invoice to the client and enters the transaction as a debit to accounts receivable and credit to sales.

    When the customer pays the invoice, the business reverses the order and enters the transaction as credit from accounts receivable and debit to cash.

    Why is Collecting Accounts Receivable important?

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    Accounts receivable collection impacts the lifeblood of any business – cash. Collecting payments late or not at all creates the kind of insufficient cash flow that stalls businesses.

    Every company selling on credit needs a process to invoice clients and collect payments. The sooner a company collects, the sooner it can turn that revenue into working capital.

    Good accounts receivable management allows a business to accurately project cash flow for smooth operations. Interruptions to cash flow create problems like the inability to afford rent or payroll.

    Every small business owner whose company sells on credit should keep an eye on accounts receivable. Routinely checking A/R collections helps to identify issues before they occur and improve collections.

    Is Collecting Accounts Receivable debt collection?

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    Collecting invoice payments are considered an operational activity and not the same as debt collection. A business must collect on its accounts receivable as a regular part of its operations.

    Debt collection typically refers to the process of going after bad debt through aggressive tactics or even pursuing legal action. Unfortunately, outstanding invoices that go unpaid for too long become bad debt, and each business decides how to handle that.

    Should my business use a collection agency?

    Selling bad debt to a debt collector is sometimes the last resort when your business doesn’t receive payment. Companies should make every effort to collect from the client, but at the end of the day, the client agrees to the terms and conditions of the invoice.

    Your business took a calculated risk in extending credit, and the client equally agreed to the risk of ending up in collections. When payment isn’t received, and the client makes no effort to rectify the situation, a company has no choice but to send delinquent customers to collections.

    Are there financing options to help with unpaid invoices?

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    Outstanding invoices are assets, but their value largely depends on the reliability of the clients who owe the money. If your business consistently gets paid but needs to access the capital in accounts receivable sooner, there are some financing options that help.

    Accounts Receivable Factoring

    Accounts receivable factoring, also called invoice factoring, lets businesses turn their accounts receivable assets into working capital. A business works with a factoring company that purchases a company’s outstanding invoices.

    When a business sells or factors invoices, it receives an immediate cash advance from the factoring company. The advance amount is a percentage of the total invoice amount. The factory releases the rest of the money when your client pays off their invoice, minus their fees.

    Invoice factoring is more expensive than a traditional business loan from a bank, but it doesn’t add to a company’s debt. The exact rates depend on the reliability of the clients paying the invoices and how long it takes to collect payment.

    Working Capital Loans

    Invoice factoring is a form of working capital financing, but there are also working capital loans, which are short-term loans to help with cash flow. Working capital loans provide a cash flow solution to small businesses.

    Merchant Cash Advance

    A merchant cash advance provides an influx of working capital based on a company’s average credit card sales. The business then repays the advance with a percentage of future credit or debit card sales.

    Business Lines of Credit

    A business line of credit provides a business with funding as needed. It’s like a credit card where the business gets a set credit limit and can draw funds to cover cash flow needs. And speaking of business credit cards, you can also look into the Brex Corporate Card to help with business expenses.

    Revenue-Based Loan

    Revenue-based financing provides businesses with working capital and flexible payment terms. The company’s revenue determines the loan amount. The company then repays the loan with a percentage of future revenue. It’s excellent for businesses with inconsistent revenue streams since the payment fluctuates with revenue.

    Other Small Business Loans

    Businesses looking for long-term loans with higher borrowing amounts can look into the following:

    Accounts Receivable Collections – Final Thoughts

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    Consistent and predictable cash flow is essential in business operations. When a company sells on credit and invoices customers, it must ensure an efficient collections process to maintain working capital.

    Companies must find ways to improve collections when clients pay invoices later or don’t pay at all. Several methods exist to encourage clients to pay on time or early.

    Small business owners who take a proactive approach to accounts receivable keep an active eye on the aging schedule and turnover ratio. Both metrics help identify trends and issues in accounts receivable collections.

    If you’re a small business and want to turn accounts receivable into working capital, you can contact us to discuss your options for accounts receivable factoring.

    We will help you grow your small business.

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