It has been proven time and again that proper management of Account Receivables is vital to ensuring your company has the necessary cash flow to meet operational needs and invest in future growth.

However, to achieve this, first, it’s crucial to have a thorough understanding of what dealing with AR mean for yur business. That’s why we created a definitive guide that covers everything you need to know about Account Receivables: what they are, how they work, and, most importantly, how to turn them into cash efficiently and consistently.

What are Account Receivables?

A balance sheet with Account Receivables highlighted

Account Receivables (AR) is the term used when referring to receivables on the balance sheet. Receivables, on their side, refer to the outstanding payments that a company is entitled to receive from its customers who have made purchases on credit. This means that the customers have received the goods or services but have yet to make the payment in full.

Usually, the payment period for the credit granted is within 30 days, but there are cases where it can vary from a few days to several months or even a year, depending on the terms of the sale agreement and the size of the purchase made. During this time, the company records the sale as an asset in its balance sheet, which represents the amount that the customers owe to the company.

Accounts Receivable is an important aspect of your company's financial management as it represents the amount of cash that is expected to be received in the near future.

When do they get created?

It’s a simple turn of events that create an Accounts Receivable. You just need two things: a sale, and a purchase made on credit.

A company sells an item or service to a buyer and extends credit to that buyer so that the total cost of the sale can be paid later, on terms that are agreed upon by the seller and the buyer. When the buyer agrees to the terms set by the seller, the purchase occurs, and the Accounts Receivable is created.

On the contrary, if the extension of credit is not given on a said purchase, meaning that the buyer pays in full at the time of sale, no account receivable is originated.

Account Receivables vs Account Payables

Account Receivables vs Account Payables

Accounts Receivable and Accounts Payable are two very important (but commonly misunderstood) terms used in accounting to manage a company's finances.

As mentioned before, Accounts Receivable (AR) refers to the amount of money owed to a company by its customers for goods or services provided on credit. In other words, it represents the amount of money that the company is yet to receive from its customers for the sale of its products or services in the past.

On the other hand, Accounts Payable (AP) refers to the amount of money that a company owes to its suppliers for goods or services purchased on credit. In other words, it represents the amount of money that the company is obligated to pay its suppliers for the purchase of goods or services. Accounts Payable is considered a liability on the balance sheet, as it represents the money that the company owes to its suppliers and needs to pay in the future.

When exchanges between companies occur, AR and AP coexist. For example, when Company A purchases goods from Company B on credit with a repayment period of 30 days, Company B will record the transaction as accounts receivable, while Company A will record it as accounts payable since it has an obligation to pay Company B.

To summarize, Accounts Receivable and Accounts Payable are both sides of the same coin.

How does offering credit affect your business?

A Law balance holding two credit cards

As we explained before, Account Receivables only occur when a purchase is made on credit. But if AR carries so much trouble, why should you offer credit in the first place?

Benefits of offering credit

  1. You can gain customers: By providing more payment options and making it easier for customers to purchase from you will bring in new customers and increase the number of recurrent buyers.
  2. It shows stability and builds trust: If you offer credit, it shows that your business is stable and trustworthy. It tells people that you have enough money to offer credit and that you're a reliable business.
  3. Encourage more expensive purchases: If you offer credit to customers, they're more likely to buy expensive things from your business. This is because they can pay over several months, which makes it easier for them.
  4. Stand out from the competition: Not all businesses offer credit, so if you do, it can make you stand out as you offer broader payment options.

Drawbacks of offering credit

  1. Dealing with missed payments: The primary risk of providing credit is the potential for missed payments. While the majority of customers will pay on time, there will be instances where they may be late in making payments or require alternative payment arrangements.
  2. You might have to hire a collections team or pay legal fees: If a customer fails to make payments, you may need to hire a collection agency to recover the debt, and they typically charge a big percentage of the amount collected. Moreover, you may also need to engage a lawyer to sue non-paying customers, which can result in legal fees that may not be recoverable.
  3. Slower cash flow: Credit sales may result in slower cash flow, as there will be more goods going out than cash coming in. This can adversely affect your ability to pay bills, especially if customers make late payments.
  4. A-game record keeping is needed: Keeping good records is really important when you offer credit. You need to keep a separate account for each customer with credit, and keep track of how much credit they have, how much they use, any interest they pay, and other important details.

How to turn Account Receivables into cash efficiently

While there are some major drawbacks, there’s no doubt that offering credit and dealing with Account Receivables is the best bet to drive a successful business. 

In order to get most of the upsides, and reduce the downsides of dealing with Account Receivables, you’ll need to solve the problem of how to collect debt efficiently and, most importantly, consistently.

For that, there are all-in-one debt collection platforms like Arrears that take care of fully automating your collection process and make keeping track of your debtors an easy task for you, so you can keep the focus on growing your business.