Every company comes to this digital market with some unique concepts and ideas, and tries to grow rapidly. For that, they provide their goods or services, and allow their customers to pay later facility to improve the relationship and trust. When a company finds any late payment, invoice due date expired, or a credit sale, then the company starts the accounts receivable process to manage its cash flow and avoid bad debts. This article is all about, what is accounts receivable, it’s importance, the working process, turnover calculation, and their benefits in detail.
Accounts Receivable Definition
It is an finance term, used to collect pending amounts from customers for the company’s goods or services that the customer already received but has not yet paid for.
Let’s see an accounts receivable example, that will help you to understand, what actually accounts receivable means. Let’s say there is an electricity provider company that continuously provides electricity to its customers. When the customer gets the electricity from this company, the use of electricity is recorded in the accounts receivable record. At the end of the month, the company sends an invoice to the customer for their usage. After a period of time, if the customer forgets about the invoice or misses the payment deadline, the company starts accounts Receivable processes and sends a reminder to deposit the pending payment.
Why Accounts Receivable is Important?
As you know, accounts receivable is an accounting or financial term that refers to the amount owed to a company for goods or services which already been delivered to the customer but have not yet been paid for. Below, we show you the importance of accounts receivable for businesses.
- Maintain Cash Flow and Liquidity: Accounts receivable plays a role in the cash flow management and helps a business to manage regular expenses, on-time supplier payments.
- Financial Health: With the help of AR, a business can quickly collect the pending amount from these customers who are not paying their bills by the invoice deadline, and it helps a business to manage its cash flow, reduce delayed payments, and improve financial health.
- Business Growth: Through AR, a company can manage its cash inflow and use these amounts in the day-to-day business operations and product or service quality improvement, which helps a business to grow rapidly.
- Customer Relations: A strong customer relationship matters for a business, and accounts receivable helps to maintain it by sending clear invoices, doing proactive communication, and enabling payment letter facilities. It builds customer loyalty, ensures timely payment, and maintains financial stability in business management.
- Make Decisions: Through accounts receivable, a business can make valuable decisions to reduce risk and maintain sustainable growth of a business by analyzing the business’s financial health, its cash flow, and the customers’ reviews.
- Ensure Compliance: By maintaining the perfect accounts receivable record, a business can maintain compliance and avoid the expensive penalties and reputational issues.
How Does Accounts Receivable Work?
The accounts receivable work process starts when a company provides its goods or services to the customer. By verifying their previous customer credits, the companies are enabled to pay letter facilities with a fixed payment due date and early payment discounts.
- After providing goods or services to the customer, the company creates an accurate and transparent invoice where the detailed information is mentioned, which the customer has already received and not yet paid for, and sends this invoice to the customer.
- When the payment deadline is completed, and the payment is still owed, then the company sends the invoice again to the customer and records the owed payment in the accounts receivable record or ledger.
- Then the company tracks what’s owed and when the company gets the invoice payment from the customer, then they update their record.
- If the company does not get any pending payment from the customer, then they send a reminder invoice and make a call to talk directly with the customer.
How to Calculate Accounts Receivable Turnover Ratio?
You can calculate accounts receivable turnover ratio by finding net credit sales and average accounts receivable manually by using the given formula.
- Now To calculate net credit sales, you need to use this formula: (Net Credit Sales=Gross Credit Sales – Sales Returns – Sales Allowances).
- To calculate average accounts receivable, you can use this formula: ((AR at Start of Period + AR at End of Period) / 2).
- Now, you can easily find accounts receivable turnover ratio using the accounts receivable turnover formula: (Accounts Receivable Turnover Ratio=Net Credit Sales / Average Accounts Receivable).
Benefits of Accounts Receivable
Accounts Receivable provides many benefits, which help to improve liquidity, streamline business operations, and build and improve the reputation of a business. Below, we provide some accounts receivable benefits that a business gets from the accounts receivable process.
- Improve Cash Flow: With the help of accounts receivable, a business can easily collect pending payments from customers, manage regular business operations, and improve the business’s cash flow and its financial health.
- Reduce Bad Debt: AR uses proactive strategies to reduce bad debts. They are applying strategies such as credit checks and offering incentives for early payment, which encourage the customers to pay invoices on time.
- Build Customer Trust: Through accounts receivable, customers receive a transparent, flexible, and reliable payment experience from the company, which enhances customer loyalty and trust in the company.
- Increased Profitability: AR helps a business improve its sales through credit, and for that, many customers are interested in it, and the company gets larger business deals, which increase profitability.
- Greater Credibility: When a company properly manages accounts receivable by showing financial stability, professionalism, and positive results to the customer, it helps a business to enhance its credibility.
Conclusion
If a company manages accounts receivable accurately and perfectly, then it can help them to improve business cash flow and sales, and can easily earn the trust of customers, investors, and lenders. In this blog, we have explained what is accounts receivable with their importance, working process, and benefits in detail. We hope you all get the accurate answer to your question, what is accounts receivable.