Accounts Receivable: What Small Businesses Need to Know

Accounts Receivable: What Small Businesses Need to Know

Marci Martin

Marci Martin

Updated Nov 10, 2021

Accounts receivable tells you how much of your cash flow is held up in unpaid client invoices. Here’s how to manage it.

  • Accounts receivable tells you how much of your cash flow is held up in unpaid client invoices.
  • While accounts receivable signifies money your clients owe you, accounts payable indicates money you owe to your service providers.
  • Communication, internal workflows, documentation, and accounting software can help you stay on top of your accounts receivable.
  • This article is for small business owners looking to master their accounts receivable and handle client invoice payments.

Accounts receivable is the lifeblood of a business’s cash flow. It helps with cash flow management by telling you which clients owe you money and how much. This lets you discern whether your cash account accurately reflects your current financial standing. In other words, accounts receivable makes the difference between worrying that you don’t have enough money and staying calm in the knowledge that money will come soon. Here’s how to track your accounts receivable.

What are accounts receivable?

Sometimes referred to as A/R, “accounts receivable” is the accounting term for the money a business should receive from its customers from the sales of goods or services. It’s the amount of money for which you’ve issued invoices but haven’t yet been paid. Once you are paid for an invoice, you’ll debit your accounts receivable for that amount and credit your cash account.

Your business’s accounts receivable is essential for calculating your profitability and providing the clearest indicator of the business’s income. It is considered an asset, as it represents money coming into the company. 

To determine profitability, add up all your assets, including accounts receivable, and subtract your total accounts payable, or liabilities, which are what you owe to suppliers and vendors. If the number is positive, the company is profitable. If the number is negative, you’ll need to make some decisions about increasing assets or reducing liabilities. 

Key TakeawayKey takeaway: Accounts receivable signifies how much cash you’re awaiting from unpaid invoices. It is a key indicator of your company’s financial health.

Accounts receivable vs. accounts payable

When contrasting accounts payable vs. accounts receivable, accounts receivable is the amount of money for which you’re awaiting client payment, while accounts payable represents what you owe your service providers – the sum of all your vendor, third-party firm and supplier invoices. 

Accounts payable reminds small business owners that what’s in your cash account isn’t quite the whole picture. If you have $10,000 in cash but owe $15,000 to suppliers, you’re not profiting as your cash account suggests. Once you cover your outstanding invoices, you’ll be in the red. 

Example of accounts receivable

Most B2B billing hinges on accounts receivable, so standard invoicing practices make for great accounts receivable examples. If you bill your clients hourly, invoicing that client every hour, day or even week would quickly become tedious for both parties. Instead, you’re likely issuing monthly invoices and expecting payment within 60 days. The value of your invoice, which represents a month’s worth of work, is part of your accounts receivable.

Why track accounts receivable?

If you don’t keep track of accounts receivable, you may forget to bill certain customers, or you may not know if you’ve been paid. You could end up providing your product for free, negatively impacting your profitability. The longer you take to send an invoice, the less likely you’ll receive payment promptly. Keeping track of accounts receivable is also a great way to document proof of income at tax time.

5 tips to help you stay on top of accounts receivable

Accounts receivable is best managed on a consistent and routine basis. In retail, each transaction is paid for immediately. With other industries, customers apply for a credit line, and they place orders against the credit line. The customer is provided an invoice and payment terms with the shipped product, payable at a later date. 

Regardless of your system, ensuring payment is crucial. Here are five tips to make sure your business stays on top of its accounts receivables:

1. Communicate with your clients. 

In a Transworld Business Advisors article, Jason Stine, business development manager for collection services company CRF Solutions, advised regular and prompt communication with clients. Stay on top of transactions; more nonpayment errors develop in the first 60 days after delivery because of insufficient or incomplete customer contact, Stine said.

Did you know?Did you know? Poor communication between clients and vendors is a leading cause of invoices going unpaid within the first 60 days after delivery.

2. Create a solid internal process. 

Determine a process for performing accounts receivable, and stick to it. Select a day of the week to create, print and mail invoices. Choose another day to print an aged accounts receivable report and contact customers who are beyond their payment-term window. As your small business grows, you may need to split these tasks among different people to stay on top of all the accounts.

3. Confirm receipt of invoices. 

Many companies have success in contacting the client to confirm receipt a week after sending an invoice. Things sometimes get lost in the mail or accidentally deleted in an email inbox. A quick inquiry about the bill’s receipt also provides you the chance to ask for feedback on the product provided, demonstrating your excellent customer service skills.

4. Extend credit with moderate terms. 

With today’s technological advances, companies can receive payment before shipping an order or performing a service. With service-based companies and high-cost goods, however, that may not always be possible. In those cases, have the client apply for a credit line. You will be able to evaluate their payment ability and set a credit limit you’re comfortable with. It also provides an opportunity to be sure both parties are clear on the payment terms and what happens if the account goes delinquent.

Did you know?Did you know? When you develop a credit policy, you’ll detail the customer’s credit qualifications, keep your clients accountable, and boost your cash flow.

5. Document everything. 

Accounts receivable documentation helps your bookkeeper with weekly or monthly inputs for financial statements and assists your accountant at tax time. From first contact with a client, keep notes on the order, conversations and agreed-upon terms. In a worst-case scenario, that documentation will also be important should you need to pursue payment through a collection agency or court.

The funds collected through your accounts receivable process are the food that fuels your company’s livelihood. Inconsistent attention to the task can starve a company’s growth, while a smooth process results in a well-fueled machine capable of achieving all of its goals.

TipTip: If you need to pursue payment by hiring a collection agency, research and find a company that works with your type of business and is familiar with your industry.

6. Use accounting software.

Creating and sending invoices, not to mention confirming their receipt and following up on late invoices, can be time-consuming – as can organizing and tracking all your accounts receivable and payable. 

Many small businesses turn to accounting software, which provides a user-friendly, highly organized interface for recording transactions and tracking accounting metrics. 

Intuit QuickBooks Online is perhaps the most commonly used accounting software. (Read our QuickBooks Online review for more information.) We find it a great choice for all small businesses, but it’s not your only option. For example, FreshBooks is our top pick for invoicing, which is the bread and butter of accounts receivable. (Check out our FreshBooks review for more information.) 

Key TakeawayKey takeaway: You can find several other accounting software options and their best use cases on our reviews of the best accounting software for small business.

Accounts receivable FAQs

Here’s a look at some of the most commonly asked questions about the accounts receivable process.

What is the accounts receivable process?

The accounts receivable process starts when you send a client an invoice. You’ll add the value of the invoice to your accounts receivable. Once your client pays the invoice, you’ll debit your A/R account and credit your cash account for the corresponding amount. Between these two instances, you may need to follow up with the client to receive payment.

Is accounts receivable an asset or liability?

Accounts receivable is an asset. That’s because you’re owed the money in A/R, so it has a positive cash value. Conversely, since you owe your accounts payable to your vendors and suppliers, accounts payable is a liability. 

What are the three classifications of receivables?

The three classifications of receivables are accounts, notes and other receivables. Accounts receivable is the most pertinent classification for small business purposes, as described in this article. Notes receivables pertain to debts tied to formal printed letters, and other receivables pertain to interests, employee advances and tax refunds.