In the world of business, credit plays a very important role. Credit allows businesses to expand their operations and maintain as well as add to their customer base without having to shell out cash or compromise the liquidity of the business. Credit or lending to businesses is given to help them cover operational costs, bear working capital needs, meet investment and expansion needs and likewise. Businesses can meet their credit needs from a wide range of banking and non-banking financial institutions. Several digital payment platforms have also surged that are providing credit facilities to the business. However, at the same time, it is of prime importance to realise the credit needs of the customer. Extending credit facilities to the customers, allows them to have better purchasing power. Without this extended purchasing power, many potential customers will be lost as not everyone can afford to shell out money in real-time for their expenses. Given this context, businesses especially small and medium ones have found a way to smoothly run their operations and an easier access to credit, in the form of account receivables.
By giving credit facilities to your customers, you can foster goodwill and loyalty for your brand. It is a much-needed enabling tool that allows customers to make purchases even when they cannot make immediate payments. It is important to note here that, allowing credit facilities to your customers is essentially intertwined with account receivables of your business. To put it simply when a business provides credit facility to its customers, it generates account receivables – which is the amount of money that the business has to collect from its customers in the future. To ensure that the credit facility that you are extending to your customer does not become a liability, proper management of account receivables is a must.
In this blog, we will discuss in detail, what is accounts receivables, how does it work, and other related discussions like why efficient management of accounts receivables is a must.
What are Accounts Receivables?
Before we begin to understand in detail accounts receivables, let us start with account receivables meaning. Account receivables are the outstanding amount that customers have to pay to the business, in return for the goods and services they purchase using the credit facility that the business provides. To put it in simple words, accounts receivables are the money that a business has earned, but yet not received because of pending payments.
Another way of describing account receivables is that these are the unpaid invoices that the business is expecting to collect from its customers in the future. When a business sells its goods or product to a customer, on credit, it creates account receivables. The customer has to pay the due amount on a later date, typically within the time specified in the credit contract. Business records these invoices of accounts receivables as assets on the balance sheet, as these account receivables are the amount that the business anticipates to receive in the future.
How Do Accounts Receivables Work?
Now that we have well-discussed account receivables meaning, let us understand how account receivables work. In case you need an accounting services in London or need any expert help to understand accounts receivables, having a basic idea of the process will help you select the right partner for your business. While the exact process may differ a bit from business to business, the usual framework is the same, and below we are giving a step-by-step explanation of the same –
- Creating Accounts Receivables – The initiation point of generating accounts receivable is the point when a business gives credit facilities to its customers and they avail of it. For instance, as a business, if your customer buys a good or service and he/she agrees to pay in 30 days, you will be creating an accounts receivable. This unpaid amount at the current time that you owe as a business is your asset, and this asset is recorded in your i.e., the business’s balance sheet as an account receivable.
- Laying Down Terms of Credit: Terms of credit given by a business to its customers at the time of sale essentially include two particulars for the customer to abide by – the credit period and the payment terms. The credit terms lay down the particulars about when the customer must settle the pending invoice. Usually, the credit period ranges from 30 to 90 days. Note that this is a generic estimate – the actual credit period may differ from industry to industry, or based on the business practices that are followed or based on the specific contract between the two parties if there is any. Payment terms include particulars like whether the repayment will be done in one transaction or in EMIs, if there will be any additional charges after a certain time, and likewise.
- Billing and Invoicing: The credit terms discussed above are intimated to the customers at the time of selling. Once the customer goes ahead with the credit facility, the billing process starts. In this, an invoice is generated which contains every important particular like the details of products or services that are purchased, their costs, the amount due, etc. The invoice also contains the payment terms and the due date of credit payment. The invoice thus generated is a very important document for both the business and the customer, as it shows that the business has provided the good/service to the customer and the customer is obligated to pay for the same within the due date of payment.
- Tracking and Managing the Account Receivables: With the conclusion of the billing and invoicing process, the accounts receivables are thus created for the business. As a small business, it is extremely important to keep an eye on your accounts receivables so that payments are well received on time. Usually, businesses maintain an ageing report. This report categorises the accounts receivables based on the remaining outstanding days for payment. Such categorisation will allow you to easily identify which customers’s due date of payment is nearby and you can send them a reminder for the same. Monitoring and managing the accounts receivables ensures that the credit payments are collected properly and on time.
- Collecting Credit Payments: This is a conditional step where as a business you may have to make extra efforts to collect your credit payments if your customers fail to adhere to the credit terms and do not make payments on time. In such a case multiple reminders may be sent, or a direct one-to-one conversation through a phone call may also help. In extreme cases, you may have to take the help of a debt recovery agency, where the purpose of such a partnership is to collect the overdue payments at the earliest.
- Recording Clearance of Account Receivables: Once the customer clears the credit dues, the business has to record the same in its books and reduce its accounts receivables vis-à-vis the credit payment received. This record reduces the value of the accounts receivables of the business and increases the cash flow and thus reflects appropriate documentation of the financials of the business.
The Need for Efficient Management of Accounts Receivables
Efficient management of accounts receivables is essential for your business’s financial well-being. Accounts receivables are your business’s assets which can turn into a loss if not managed well. Apart from this, efficient management of account receivables helps maintain the finances of your business. Let us look at how -
- Cash Flow Management: Timely collection of accounts receivables is a necessary condition to maintain a healthy cash flow. When customers pay on time, the business gets the funds necessary to cover its operating expenses, invest, and meet financial obligations.
- Working Capital: Accounts receivables are a part of working capital, which represents its current assets minus current liabilities. Effective management of accounts receivables ensures that your business has sufficient and flowing working capital to run its operations smoothly.
- Risk Mitigation: Delayed or unpaid invoices can result in financial instability. Not managing accounts receivables efficiently may lead to struggles in meeting your obligations, like paying suppliers, employees, or lenders. This can lead to financial distress.
- Customer Relationships: Accounts receivable management is more than just collecting pending money. It essentially requires maintaining positive customer relationships. Effective communication and a transparent billing process can foster goodwill and trust, and help expand the business further.
- Data for Decision-Making: An important element of efficient management of accounts receivables includes evaluation of the corresponding data. By analysing receivables, businesses can identify trends, assess the effectiveness of credit policies, and make informed decisions about credit extension, debt collection, and sales strategies.
Partner With Unicorn Accounting for Efficient Management of Accounts Receivables
Unicorn Accounting – is a highly trusted accounting firm that ensures your finances are well-optimised and all your financial compliance needs are also well taken care of. Whether it is tracking your receivables, ensuring smooth cash flow, or assisting in credit collection, Unicorn Accounting offers you unique services as per your requirements. If you are looking for an accountant in London, to help you with the management of your business’s accounts receivables or any accounting or financial advisory services, then look no further – we bring to you expertise, efficiency and peace of mind.