Accounts receivable: a comprehensive guide

It’s no secret that there is a lot of different accounting terminology associated with the world of finance. There are countless terms relating to key processes that keep a business’s finances in check, and it’s clearly important for anyone working in this area to be familiar with them. Still, if there was a hierarchy, there’s no doubt that “accounts receivable” would be near the top of the list – such is its importance. 

That’s why this blog will walk through what accounts receivable is and exactly why it’s important enough to deserve a crowning spot in the glossary of accounting terms. We will cover the essentials of accounts receivable, highlight key procedures to manage it, and explain its impact on your business’ financial health, along with some examples. 

What is ‘accounts receivable’?

Accounts receivable (AR) refers to the outstanding invoices a company has from sales on credit. In simpler terms, it’s the money owed to a business by its customers for goods or services delivered but not yet paid for. It’s worth noting that accounts receivable is also sometimes known as “trade receivables” or “trade debtors” – but these terms all refer to the same thing. 

What’s more, accounts receivable isn't just a balance sheet entry – it’s also often the name of the accounting department responsible for managing and collecting these payments. The accounts receivable team ensures that customers pay within agreed terms and resolves any disputes that may arise, keeping cash flow steady. Without this, a company may lose track of the money it is owed for services already rendered. 

Key elements of accounts receivable

So, we know that managing accounts receivable is a multifaceted task designed to ensure that businesses receive the money they’re owed. But what are the key elements involved in accounts receivable? Let’s take a look below:

• Invoices - the formal documents issued to customers outlining the payment due for goods or services that have already been delivered. This is where accounts receivable begins.
  
  
• Trade receivables - money owed directly from the sale of goods or services. It forms the bulk of what companies track in accounts receivable.
  
  
• Non-trade receivable - funds owed to a business that aren’t related to its main operations, such as tax refunds or insurance payouts. These typically do not require an invoice (for example, a wage advance for an employee).
  
  
• Ageing - a method of sorting receivables by how long they’ve been unpaid. Ageing reports help companies identify overdue invoices and are also important in helping flag customers who have poor payment histories.
  
  
• Accounts receivable financing - a method where businesses sell outstanding invoices to third parties in exchange for immediate cash, helping with liquidity. Essentially, this is when a company borrows against their invoices in order to more immediately access the money they’re due.
  
  
• Bad debt - sometimes customers don’t pay, and the debt has to be written off. This is known as “bad debt” and is accounted for in a company’s financial records.

Accounts receivable examples

To better understand the role of accounts receivable in business operations, let’s explore a few real-life examples of how this can play out in day-to-day finance roles and duties:

1. Timely invoice payment
   
   This is the ideal scenario. A business provides services and sends an invoice with net 30-day payment terms. The customer pays within the window, and the company seamlessly records the payment in its cash account, thus maintaining smooth cash flow.
   
   
2. Delayed payment with interest
   
   Let’s look at an example of what might happen when payment of an invoice is delayed or late. In this case, a contractor might deliver goods and then send an invoice for £5,000, but the customer pays 45 days late, this will then incur a late fee. While the payment is eventually made, the business has had to absorb the delay, temporarily affecting its cash flow.
   
   
3. Disputed invoice
   
   Finally, let’s consider what might happen when an invoice is disputed. This sometimes occurs when a company provides a service on credit, but the customer then disputes the pricing. Negotiations between the organisation and customer will then need to take place, and may lead to the withdrawal of the initial invoice. Necessarily, this situation delays revenue and often causes trouble in a company's financial forecasting as the amount a finance team had expected to receive has changed due to the dispute.

Accounts receivable vs. accounts payable

While accounts receivable represents money owed to a company, accounts payable (AP) refers to money a business owes to its suppliers. Both AR and AP play essential roles in managing cash flow. Accounts receivable ensures incoming payments, while accounts payable manages outgoing obligations. Together, they give a picture of a company’s financial health. 

How does accounts receivable impact a business?

The proper management of accounts receivable can make or break a company’s cash flow. Consider the following scenarios to get a full grasp on the way it might affect a finance team, and by extension, the whole organisation: 

1. Incorrect AR calculation
   
   If accounts receivable is calculated incorrectly, it distorts financial statements, potentially leading to inaccurate cash flow forecasting, erroneous financial decisions, and ultimately a potential unexpected lack of liquidity.
   
   
2. AR increases without payment
   
   When accounts receivable rises without being collected, the company faces a cash shortfall, which could hinder its ability to cover operational expenses, even though it technically "owns" the money. This can quickly spiral in terms of knock-on effects and may lead to cutbacks, necessitate borrowing, and could even result in debt issues.
   
   
3. Accumulation of large but reliable AR
   
   A company with reliable customers may have significant accounts receivable if the products they sell have long lead times. Although they know payments will eventually come, it may require creative cash flow solutions like accounts receivable financing to manage day-to-day operations in the meantime.

How to keep on top of accounts receivable

No business wishes to miss out on money that they are owed. As such, management of accounts receivable is a very important job. Fortunately, there are a variety of tried and tested methods to make sure that everything runs smoothly:

• Staying on top of accounts receivable means using the right tools to ensure timely invoicing and effective money collection. Most companies have now ditched managing the billing and collection process using paper trails in favour of electronic recordings and management. Some businesses use tools like online portals as “self-service” options where customers can receive invoices, view statements and pay their dues without needing to seek out a specific email.
  
  
• There are also accounts receivable procedures to consider. For example, by using ageing reports, businesses find it easier to monitor overdue invoices, send timely reminders, and take action when payments are late. These reports categorise outstanding receivables by age, helping prioritise collections and anticipate potential bad debt.
  
  
• A growing number of finance teams are turning to automated reconciliation as this can be especially helpful in keeping accounts receivable accurate and up-to-date.  This is because it allows businesses to track incoming payments in real time, reducing the risk of errors and making financial forecasts more reliable.

How to accurately manage accounts receivable

Given that payments can be made at different times, in parts, or with varying interest rates, managing accounts receivable can be complex. This is why accounts receivable reconciliation is vital and must be managed correctly.

However, the likes of Aurum Solutions’ automated reconciliation platform radically simplifies ensuring that the actual amounts owed to businesses and collected by them match what is recorded in their accounting system. Better still, regardless of whether a company prefers to run a “point in time” reconciliation or a “day + 1” reconciliation, the end result remains one of simplicity, accuracy, and efficiency.

How Aurum achieves this for standard accounts receivable reconciliation is by automatically collecting outstanding invoices for the relevant period and cross-referencing them against payments received in their bank account over the same time. At the end of this process there is also the option for journal files to automatically be created and sent to the correct accounts, keeping them up to date.

Whilst this might sound simple on paper, the reality is that it is extremely time-consuming when conducted manually. Yet, the opposite is true when Aurum’s automation is deployed - British Land save 800 hours a year by using Aurum.

Moreover, accounts receivable can become complex in certain scenarios, resulting in automation not only being beneficial for speed purposes but also for overcoming complications that can result in human error. For instance, if a property management firm receives a bulk payment from a retailer that rents multiple stores from them, the property management firm needs to know which stores have been paid for. This might at first seem elusive but Aurum’s intelligent matching and one-to-many reconciliation process solves this accounts receivable issue for British Land, Savills Property Management, and many more with ease.

The final account

Overall, management of accounts receivable is important for cash flow in the here and now, it determines whether or not a firm can accurately forecast their financial future, and it is ultimately why companies go into business.

Like so many fundamentals of finance, it too can be greatly assisted by automated reconciliation. To discover how for yourself, book your Aurum demo today.