What Are Accounts Receivable?
A healthy balance sheet in your business will always include an “accounts receivable” section under “current assets.” Accounts receivable is the money that customers or clients owe for services and products that have already been rendered. This takes the form of credit and is typically given in an invoice with a specified time frame for payment. This credit is treated as an asset, and customers are legally obligated to pay.
To use accounts receivable, you must allow some sales to be made on credit, such as credit available for frequent customers or simply for higher-priced items. Most consultants, attorneys and other service providers operate using accounts receivable and bill the client after services have been rendered.
A successful accounts receivable system needs an organized setup from the moment the sale is made through the time to collect the debt. It involves creating invoices for debts and then delivering those invoices, either by mail or electronically, to the customer. Using an Accounts Payable and Receivable form can help you track this financial information, and this guide can walk you through how to make an invoice.
You will need the policy to ensure timely payments instead of just sending an invoice and waiting. Typical policies are 30, 45 or 60 days (these are usually noted on the invoice as “Net 30” or “Net 45”). Remember, the longer you wait, the less likely the client will remember to pay you. Consider using late fees or interest to encourage on-time payments.
You’ll also want to establish a policy for exactly how much credit you will allow customers and who will be approved for credit before you begin allowing these transactions. If there will be an approval process or credit check, inform customers of this before you allow them to use credit.
You also may need an electronic bookkeeping system. A formal system is easier to use and helps ensure prompt pay. By using an organized billing system, you look professional and therefore keep a good relationship with customers.
How to Use Accounts Receivable
Setting up a bookkeeping process requires a few simple steps:
- You will need a bookkeeping software system to create and track accounts. However, if you are a small business and have very few credits and invoices, you can use the pen-and-paper method to record transactions. Microsoft Excel works well to help calculate with this method.
- It is recommended that the business owner handle all of these transactions and maintain the balance sheet until they understand the process well enough to assign the task to someone else.
- You need to create an account for every customer, including their name and contact information. This makes it easier to track invoices, credits and payments.
- Invoices for customers need to include all the details of the transaction, including what was purchased, the cost and the plan for payment. You should also list any plan for late charges and/or interest on the credit.
- When sending invoices to customers, using official documents with your logo will appear more professional and are more likely to get a positive response. This will help protect your relationships with customers.
- To record an invoice, you need to debit a receivable on your balance sheet and then credit a revenue account.
- When the credit is paid by the customer, you will then debit cash on your balance sheet and credit the receivable. A good software program can make this process easier.
- You can then measure the net value of accounts receivable by subtracting the balance of an allowance account from the accounts receivable.
- Remember, collection is very important to ensure that your business makes a profit. Make collecting a priority. Regularly review invoices of customers and follow-up often. Deliver invoices as soon as possible after purchase and on a regularly set schedule until payment.
- As a last resort, delinquent payments can be sent to a third-party credit agency for collection.
- If using your accounts receivable as collateral for a short-term loan, you will need an Assignment of Rights and Accounts Receivable.
- Be sure to make copies of documents (such as receipts and shipping invoices) to prove any owed debt.
Keeping a consistent and organized accounts receivable system will help you maintain a healthy balance sheet and ultimately be more profitable. You will encourage stronger relationships with customers and improve your financial stability by correctly implementing accounts receivable.