Understanding what is an account receivable is critical for an entrepreneur. Account receivables are payments or proceeds that a company expects from its customers who have been offered goods or services on credit.
Account receivable exists after a sale has happened and a customer is issued an invoice. The time a company allows between the credit services and the payment of the debt is known as a credit period.
The credit period for account receivable is usually short, ranging from a few days to weeks, or months. The value of the account receivable often depends on the creditworthiness of the customer and the type of relationship the customer enjoys with the company.
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Differences Between Accounts Payable and Accounts Receivable
Before further discussing accounts receivable, it is worth dispelling any confusion between account payable and account receivables.
Accounts payable and accounts receivable can be one payment but depends on who gives the credit and who receives the credit.
Account payables represent your company’s obligation to settle short-term debt, while account receivable represents the money that is owed to the company, typically from its customers.
What is the Importance of Accounts Receivable?
It is the desire of some organizations to be debt-free (to owe or to be owed by no one). In real life, however, debt is often inescapable.
Accounts receivable are instruments of debt that can play a vital role in growing a company’s portfolio and income. In fact this is a very important element for investors if you ever consider to raise capital. Keep in mind that in fundraising storytelling is everything. In this regard for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
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Furthermore, companies may use accounts receivable for several reasons.
Build Customer Loyalty
As businesses scale up, it is easier to get more and more customers, but once in a while, customers aren’t able to buy goods in cash. Your business is forced to offer credit options to customers.
The credit options offered are what create account receivables. Maintaining easily referenced and highly organized account receivables allows companies to boost sales by allowing their loyal customers to get more credit.
Businesses can establish good faith with its customers and pave the way for future sales hence increase brand loyalty.
Track customer Credit
Data regarding past purchases and plans allow companies to make individualized decisions on who it can offer credit. The credit is often offered to clients who have a great payment record on account receivable and declined to those who have a shoddy record.
Well-maintained account receivables are sorted by different metrics such as length of time of pays, types of purchases, and so on. The data is fundamental to tracking customer habits over time.
Increasing Overall Sales
Credit sales can offer customers a way to get more service or goods at a time and can even increase panic purchases.
More goods and services coupled with brand loyalty can increase the overall sales in the long term. Though it is good to exercise caution on credit sales as they are risky.
Improves Fiscal Organization
Account receivables help to diversify business streams of income as the business can have cash and credit. A business is seen to be robust when it has well-run financials and great client management that can guarantee more sales overall.
A good analysis of previous customer borrowing trends can help a business in decision-making and improve the business’s overall fiscal outlook.
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Demerits of Account Receivables
While account receivables offer obvious benefits to a business, there are some challenges and drawbacks that businesses face when using account receivables. You may experience any of the following drawbacks when using account receivables.
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Every time you allow credit purchases in your business, there is a risk that the customer may not pay back what they owe you. It is good to extend credit to customers who have the best credit score and reliability in making payments.
Account receivables can easily turn into bad debts. Bad debts are those debts whose recovery cost exceeds their value.
Require Frequent Follow Up
Recovering debt is a difficult process, and at times it requires companies to follow up on the debt regularly to avoid accumulating bad debts. Since you have to follow up on the debt, it is time-consuming and requires a good follow-up procedure.
Recording, printing, and sending out invoices cost more than cash payments. You may need to invest in multiple resources such as a collections team or accounting software to track account receivables.
How to Minimize Accounts Receivable
Having few accounts receivable on the company portfolio is healthy and can boost overall financial projections. It is, however, good to keep accounts receivable at a minimum, or within your risk tolerance.
Keep Track of Outstanding Bills
Keeping tabs on the total receivables can help you track the payments you expect to collect on, and to keep the account receivables at a sustainable rate, and avoid bad debt.
One of the most effective ways of reducing outstanding account receivables is getting paid. You can increase the pay rate by setting clear deadlines with clients regarding bill payments. You have to be clear on the onset to reduce client default on the pretext of low information.
Communicate with Clients
Showing your customers that you value cash payments can help reduce accounts receivables. Receiving customer payments can ensure that you can pay your supplier on time.
You should send prompt notifications to your customers so you can receive the money on time. The better the communication, the better the customer relationship and faster payments.
How To Increase Faster Payment on Account Receivables
Late payments on account receivables can be a lag on your business. The process of collecting is time-consuming and costly. You can accelerate payments using the following methods.
Provide Financial Incentive
Customers love financial incentives. The most common incentive is offering discounts on all outstanding invoices. You can choose to offer a 2% invoice for paying the debt within, say, 15 or 30 days.
By attaching financial incentives to early payments, you can also attract more customers to the business.
Schedule Regular Reminders
Setting up a good reminder system can help the customers settle the payment much more quickly, as late payment or non-payment can be due to forgetfulness.
You should use different reminder channels such as sending invoices, sending reminder emails at an interval of 15- 30 days. These reminders keep the debt fresh in the customers’ memory.
Create a Credit Policy
Extending credit to customers is always a risky venture. A good credit policy can help you make clients accountable. Create a sustainable credit policy that meets the specific needs of the business.
Sustainable credit policies should detail credit qualifications, credit limits and terms, and invoice and debt collection terms. The credit policy can even be a deterrent to debts.
Recourse for Debt Non-Payment
Debt recovery is not a walk in the park and may result in debt non-payment despite due diligence and offering customers good terms. You should have a method of recourse to help you recover the debts. Often this includes having collateral you can seize.
When There Is a Chance of Recovering Debt
When you believe that the customer can repay your account receivables at a low cost to the debt in question, you can use one of the following methods in debt recovery.
Add the customer to a Long-term Account note. When you have a creditworthy customer who has an issue with late payments, it is great to add the customers on a long-term note.
A long-term note is a promissory note that represents a loan to be paid after a longer period of more than 12 months.
Stop Providing Good or Service to Customers
When you have a customer with late payments, it is a good practice to stop offering the product or service to avoid incurring bigger debts. The services are often stopped after a bill is due for more than 60, 90, or 120 days.
You should inform the business of the limitation. Most businesses or customers may pay to keep receiving the goods or services. Some may terminate the contract altogether.
Get Help From Collection Agencies
Whenever it is impossible to collect your debt from the customers using the above methods, it is time to hire a collection agency. You can also hire a collection agency whenever it is difficult or impossible to contact your clients.
Inform the customer of the steps you have taken in hiring a collection agent. Offer them a chance to pay the debt before letting the collection agency collect a debt on account receivables, and potentially add to their costs.
Be sure to choose your collection agency wisely, as they will be a reflection of your brand, and will directly influence your online reputation, reviews, and customer relations.
When There Is Little Chance of Receiving Payment
Business is unpredictable, and once in a while, you may have a situation where the customer has poor financial management and cannot pay their debt.
The case may be either the customer is unwilling to pay the debt, and the cost of recovering the debt is more expensive than the debt.
Or the customer is unable to pay the debt due to bankruptcy or insolvency. When you have bad debt, you can charge off the debts. Bad debt may be deducted from gross income when it comes time for taxes.
Top 5 accounts receivables mistakes
Working with debt is stressful in many businesses. Businesses may incur bad debts from account receivables due to poor conduct in debt management and cash flow. The most common mistakes in debt management are:
1. Fear of Ruining Relationship With Client
Accounts receivables are seen as tools to help increase sales and build customer loyalty. Businesses are often afraid of giving customers prompt reminders of debt payment in fear of losing the client.
Some businesses are even afraid of asking for advance payments and, in turn, want to offer customers ample time to release payments.
2. Offering Limited Payment Options
Some businesses in the 21st century still rely on traditional payment options despite many payment options available. The over-reliance on checks and traditional methods of cash collection lead to delays in payment and may turn off many potential customers.
3. Following Debt Repayments Shallowly
Many firms rely on a broad overview of data reports for accounts receivables. The firms may not be thorough digging into the parameters such as real errors in debt payment, time taken to clear debt, and examining if the steps taken in debt collection were appropriate.
This can sour customer relationships unnecessarily, and hurt the brand.
4. Over-Reliance on Paper Usage
Some firms may still rely on papers to manage their accounts. The papers are used to send reminders to clients or maintain billing statements. Paper usage is not robust as digital systems and often delays timely delivery of invoices and can have issues like misplaced statements.
5. Ignoring Previous Account Receivables
Fast-moving businesses often end up forgetting or ignoring previous accounts receivable. There is often limited follow-up or no follow-up at all.
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Best practices handle accounts receivables
Businesses should follow good debt management principles when following up on accounts receivable. They should follow established principles and good account receivables management.
The most basic practices are:
1. Speed in the Billing Process
Sending out bills and invoices regularly is one of the most effective ways to reduce account receivable payment delays. You should invoice clients bi-weekly or monthly to attract faster payments.
Establish deadlines with your customer in the repayment of debts and track the payment before they can fall into bad debt.
2. Have a Team or Software to Track Account Receivables
Rather than relying on a piece of paper, it is good to digitize your account receivable using a system that is easy to track any late payment. You can add a team to help track customer response and make follow-ups.
3. Create Collection Procedures and Policies
What happens when a customer defaults on payments? What requirements do you have for debt collection? You should create a clear debt policy that can guide your clients on what is expected of them and also allow businesses a blueprint on what to follow.
You should define a debt collection procedure plus issues like bill appeals, accepted payment methods, past-due notifications, discounts on early payments, when to turn over the collection to collection agencies, and due date invoicing.
Accounts receivables are tools that businesses can use to leverage their success; they should however be used with moderation to avoid bad debts.
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