Understanding Accounts Receivable: A Foundation for Business Success

Ever felt like you’re making great sales but somehow always struggling with cash flow?

Many businesses, especially SMEs and startups, face this challenge. The problem isn’t always about making sales but about getting paid on time. But what exactly is AR, and why does it matter so much?

What is Accounts Receivable?

AR is simply the outstanding invoices a company has or the money it is owed by customers for goods or services delivered but not yet paid for. It represents a company’s short-term financial strength and liquidity, recorded as a current asset on the balance sheet.

From a financial management perspective, AR is the heart of the working capital cycle. It directly influences cash flow and can stress the ability of a company to meet its future goals.

Impact of Accounts Receivable on Cash Flow

Effective management of AR is essential for the preservation of sound financial position. An organisation, therefore, can have large ARs but very ineffective measures toward collection of such arrears might not survive to meet day-to-day expenses. This might appear to be excellent in financial stature, often termed as “profit-rich but cash-poor”.

Here’s where things get real: Atradius indicates that over 50% of all B2B invoiced sales in the USA, UK, and Asia are now overdue. What’s worse is that Barclays reported that about 58% of payments are late in the selected parts of the UK and parts of Asia are seeing delays of over 60%.

The Federation of Small Businesses (FSB) states that a whopping 50% of all debts owed to SMEs are delayed, with 10% by over 30 days and an additional 12% by over 60 days. This delay is costing UK small firms billions per year seriously constraining their abilities to invest, grow, and hire.

Poor AR management can lead to several significant issues, including:

Delayed payments make it hard to cover payroll, rent, and utilities.

Unpaid invoices lead to financial losses.

Businesses may rely on loans, increasing interest expenses.

Late payments can hurt supplier relationships and terms.

Limited cash flow restricts reinvestment and expansion.

Chasing overdue payments adds administrative costs.

Persistent AR issues can lower credit ratings and financing options.

Example of Accounts Receivable: A Small Bakery

Imagine a small bakery called “Sweet Treats” that supplies cakes and pastries to local cafes and restaurants. Sweet Treats offers its customers a 30-day credit term, meaning the cafes and restaurants have 30 days to pay for the goods they receive.

How AR Works:

Sale on Credit: On January 1st, Sweet Treats delivers $5,000 worth of baked goods to a local cafe. Instead of receiving immediate payment, Sweet Treats records this amount as accounts receivable.

Invoicing: Sweet Treats sends an invoice to the cafe, detailing the amount owed and the payment due date (January 31st).

Tracking Receivables: Sweet Treats monitors its AR aging report to keep track of outstanding invoices and ensure timely follow-up if payments are delayed.

Impact of AR on Cash Flow:

Positive Impact: If the café pays its invoice on time, by January 31st, Sweet Treats will receive the amount of $5,000 to cover necessities such as ingredients, employee wages, and rent. It also maintains steady cash flow and financial stability.

Negative Impact: If the café does not settle the invoice on or before January 31st, cash flow is hindered at Sweet Treats. The bakery will then face serious issues in paying its supply vendors or any existing liabilities with cash of $5,000 not available. They may have to tap into reserves or borrow from some sources at higher costs than necessary.

Practical Tips to Track and Manage Accounts Receivable Effectively

Establish Clear Credit Policies Not all customers should receive the same payment terms. Conduct creditworthiness assessments before extending credit. Define credit limits and payment terms that align with your cash flow needs.

Automate Invoicing and Payment Reminders: Utilising cloud-based accounting software allows businesses to:

Generate and send invoices automatically.

Set up payment reminders for overdue accounts.

Track AR balances in real time.

Monitor Accounts Receivable Turnover Ratio: This ratio indicates the effectiveness of a company in receiving payments from customers. A higher ratio shows that collection is speedy and good. A lower one means collection is problematic.

Offer Multiple Payment Options: Offering various facilities for payments, including bank transfers, credit cards, direct debits, and digital wallets, can speed up collections and avoid delays.

Implement a Follow-Up System A structured follow-up process ensures overdue payments are addressed promptly. This includes:

Sending polite reminder emails before and after due dates.

Making follow-up calls for significantly overdue invoices.

Offering early payment discounts to incentivise timely payments.

Enforce Late Payment Penalties and communicate late payment penalties in your contract terms. This discourages delays and ensures that customers prioritise their outstanding dues.

How Pulse Supports Businesses with AR Management

Many businesses face similar challenges with AR, which is where Pulse comes in. With powerful modules to track, manage, and optimise their accounts receivable in real-time. From invoice tracking to predictive cash flow insights, Pulse has enabled numerous companies to reduce late payments and enhance liquidity.

Studies show that 75% of finance leaders now view AR as a strategic function that drives decision-making and financial planning. This is the very reason we have implemented our new Debtor Analysis module, which gives businesses insight to enable finance leaders to treat AR as a fundamental part of their strategy.

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Explore Pulse today and take control of your receivables like never before! Book a demo today at info@mypulse.io.