If Accounts Receivable is just sales, it's basically money in the proverbial bank, right? Not exactly. In the accounting world, Accounts Receivable is sort of like cash inflow “in waiting.” It’s cash legally owed to you, which in theory is good, but it’s not cash in hand. The same thing applies to accounts receivable. So exactly what is Accounts Receivable? Let’s break it down…
So What is Accounts Receivable Anyway?
When you make a sale and have delivered the product or performed the service, but your customer has yet to pay you for it, that amount of money is still coming to you. Cash “to be received” is filed under the category Accounts Receivable in accounting terms.
You’ve actually used Accounts Receivable your whole life. If you've ever earned a paycheck, you've used accounts receivable: you performed work for your employer and you were paid, most likely, weekly or twice a month. You made the outlay by working and your paycheck, which you expect on a regular interval in the future, was an Account Receivable.
Why Do Accounts Receivable Matter?
Now that we know what it is, let's learn why Accounts Receivable is important. At a high level, it's important because it affects your cash flow. We’ve talked about what cash flow is, why it matters and why it’s important to keep inflow greater than outflow, but Accounts Receivable is sort of part of a no man’s land between inflow and outflow. It will be inflow, but isn't yet. And since you made the outlay of the service or product, it’s a cash outflow. But it will be returned. Having Accounts Receivable is a positive thing for your business: it means you’re making sales which are an important first step towards business success. But the second step is just as important: collection.
Think of Accounts Receivable like mini loans to your customers; credit that you are extending because you’ve paid for the inventory and delivered it to them or you’ve performed a service for them and they still owe you. You're basically fronting for them. And the quicker the turnaround on Accounts Receivable the better. Great, you say, but how?
Set the Right Terms from the Start
Accounts Receivable can have varying payment terms and cycles. The typical payment cycle for goods or services ranges 30 to 90 days. It's up to you to negotiate the right payment terms in a contract from the get-go. The longer the payment term the more credit you are extending to your customers. Conversely, the shorter the payment term, the quicker you get your money—theoretically. Set terms that work financially for you, but are also fair to your client/customer.
Make it Easy for Your Customers to Pay You
Sounds simple right? Well, as you likely know, getting people to pay you is hard! You can make it easier for them by giving them options that snuff out all the potential excuses. From electronic transfers to mobile credit card payments like Square to Paypal, payments technology has come a long way since the days of written checks. Over time, you'll learn which payment methods are most preferred to your customers or clients. But don't go to far: getting paid is about doing good work and being firm. That said, consider these three criteria when considering payment options:
How easy is it to use? Think about the customer’s perspective as well as your own.
What is the fee structure and how much does it cost? You can build those costs into your pricing scheme, but you don’t want that driving up your price as to push you out of the market.
How reliable is it? You want a service that’s established and credible.
Make customers Want to Pay You—Early and on Time
Everyone likes bonuses or rewards, right? Consider creating some incentive for customers to help you turn those Accounts Receivable to in-hand cash early! You could try discounts, free shipping, bonuses, gifts, loyalty/points programs, or future credits for early payment. This will not only help you boost your bottom line, but it will bolster the likelihood of getting that customer to be a repeat client.
You can also work on the other side and make a late payment fee. A fee for late payment could work as a preventative measure and encourage people to pay on time. But think carefully about how you want to set up your late payment fee: you want to keep happy customers and drive cash inflow. Certainly there is a time and place to collect late fees, but also consider the payment history and loyalty of a customer before slapping them with a fee. The best thing is to be clear about the policy and apply it evenly.
One final note: Accounts Receivable, on a balance sheet, is seen as an asset because it's guaranteed money coming back to you. Accounts Receivable are guaranteed because the customer has a legal obligation to pay you and it’s an issue that you could, in an extreme case, take to court for payment on the contract.
And that, in a nutshell, is Accounts Receivable. To fully manage cash flow you’ll need to know the other side of the accounts receivable coin, Accounts Payable. We’ll be covering that next, here on the Kashoo blog!