Accounts Receivable Management: What It Is & How to Improve It

Published on December 5, 2023
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Accounts receivable management involves tracking and securing customer payments after orders have been placed. Much more involved than cashing a check or ticking a “paid” box, A/R management directly impacts your business’s cash flow and liquidity and, ultimately, your organization’s bottom line. 

Read to learn about common accounts receivable management processes, challenges, best practices, and more.

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Why does accounts receivable management matter?

At its core, accounts receivable management ensures that an organization promptly receives payments for goods and services. By tracking outstanding invoices, promptly addressing late payments, and nurturing customer and vendor relationships, businesses with effective A/R management can more efficiently cover operational costs, invest in growth opportunities, optimize their cash flow, and weather unforeseen financial challenges. 

Conversely, a business without a well-organized accounts receivable management system risks encountering cash flow gaps, hindered ability to meet immediate financial obligations, missed growth prospects, and, in extreme cases, bankruptcy.

Accounts receivable management is also a critical component of customer relationship management. Timely and accurate billing and professional communication regarding payments build trust and confidence in business-client relationships.

Effective accounts receivable management is not just about financial prudence; it’s a strategic approach that safeguards a company’s financial health while fostering positive customer experiences, laying the foundation for sustained business growth.

Accounts receivable management processes

Though the exact process may vary from one business to another, every organization’s accounts receivable process revolves around billing — when customers are sent invoices to notify them of outstanding bills — and payment collection — when those invoices are reconciled. The actual step-by-step accounts receivable management process goes something like this: 

    1. A customer places an order: This step technically initiates the accounts receivable process, but remember that your customer relationship management of other clients can help get new clients in the door.

       

    2. The company evaluates the customer against its credit standards: Many businesses operate on credit, allowing time to elapse between the placement of an order and payment. It’s essential, then, that a company assesses the customer’s creditworthiness before extending credit. If the customer does not meet the company’s standards, the company may require that the customer pay upfront.

       

    3. The company sends an invoice to the customer: After credit approval, the company generates and dispatches an invoice detailing the products or services provided, along with the payment due date and terms.

       

    4. The company manages collections monitoring for late payments: A proactive approach involves monitoring payment schedules, sending reminders, and communicating to ensure timely payments and maintain a healthy cash flow.

       

    5. When necessary, the company investigates and addresses disputes: When disputes arise, the company investigates the issue, resolves discrepancies, and ensures accurate invoicing, avoiding delays in payment collection.

       

    6. Payment processing: Upon receipt, the company processes the payment using the chosen method, verifying the transaction’s authenticity and accuracy. The received payment is accurately matched with the corresponding invoice (via cash application and other methods), updating the company’s records and customer balances in real-time.

While the above outlines the general payment management process, another important (and ongoing) aspect of A/R management is the reporting and monitoring of a company’s current state of finances.

Companies either choose to outsource these accounts receivable responsibilities or opt to do them internally. Here, A/R managers closely monitor metrics such as the average collection period, customer payment trends, outstanding receivables, and aging reports.

By regularly gauging their financial standing, companies can gain valuable insights into their cash flow, identify potential issues or bottlenecks in the A/R process, and make informed decisions to optimize their financial stability and overall business operations.

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Common accounts receivable management challenges and complications

Business growth signals that a company’s cash flow and financial standing are at peak health, but this is when receivables management becomes more crucial than ever. An influx of customers means companies must scale their management practices to accommodate more inquiries and invoices. But if the company’s current A/R management system isn’t as strong as it should be, those cracks can spread and cause financial issues. Here are some common challenges businesses face as a result:

  • Invoice errors: When companies send out invoices late or there are data inconsistencies, these errors can lead to delays in payment processing, customer disputes, and ultimately, frustration for both the business and its clients.

  • Late payments: Late payments can severely affect a company’s cash flow and financial planning, often stalling its ability to replenish and maintain available resources and offset operational costs.

  • Missed reminders: Companies that aren’t using accounts receivable automation tools to help remind customers of late payments risk further delaying collections and overlooking invoices.

  • Writing off unpaid invoices as bad debt: Sometimes, businesses face the unfortunate reality of writing off unpaid invoices as bad debt, which can have a significant negative financial impact.

  • Allocating payments incorrectly: Mixing up invoices or asking for an incorrect payment amount can lead to confusion and dissatisfaction among customers and erode their trust in a business.

  • Poor customer experience: A negative customer experience in the accounts receivable process can damage client relationships and affect future business opportunities.

  • Limited employee time: Even with a strong accounts receivable management system, not having enough employees to monitor it can lead to unaddressed customer inquiries, a higher risk of human error, and missed invoices.

Businesses that take the time to invest in, strengthen, and streamline their accounts receivable processes position themselves for long-term financial success.

Best practices to improve your accounts receivable management

These best practices take the guesswork out of A/R management and can help your business reduce the risk of encountering the common challenges mentioned above.

1. Set standards for acceptable credit 

Establishing clear standards upfront for extending credit sets the foundation for financial certainty and better business planning. This involves thoroughly evaluating a customer’s creditworthiness, outlining credit limits to mitigate the risk of excessive outstanding balances, and defining credit terms and payment schedules. 

2. Be clear about your payment requirements and deadlines

Timely payments aren’t possible without clear payment deadlines. When communicating payment requirements, specify payment interval terms, such as “net 30” or “due upon receipt,” to clarify when payments are expected. Also, provide information on accepted payment methods, including online payment options and bank transfer protocols. For added assurance, implementing automated systems to send payment reminders as due dates approach can help minimize oversight and overdue payments.

3. Make it easier to pay you

Simplifying the payment process encourages prompt payments and reduces friction for customers. The best way to do this is by providing online payment portals where customers can submit payments electronically. Offering various payment methods, such as credit cards, electronic funds transfers (EFT), and mobile payment apps, helps cater to diverse preferences and makes the payment process more convenient. On the business side, consider implementing automation to process payments efficiently and reduce the need for manual data entry that can lead to errors.

4. Know how to measure accounts receivable management performance with appropriate KPIs

Effective accounts receivable analysis relies on key performance indicators (KPIs) that can give you a glimpse into how healthy your business cash flow is. Collect and review data for the following A/R KPIs:

  • Days sales outstanding (DSO): Calculate DSO to assess the average time collecting payments after a sale. A low DSO indicates efficient collections, reflecting a shorter cash conversion cycle.

  • Average days delinquent (ADD): ADD measures the time payments are overdue. A decreasing ADD suggests that customers pay closer to their due dates, while a higher ADD translates to consistent payment delays.

  • Accounts receivable turnover ratio: This ratio quantifies how quickly outstanding accounts are collected during a specific period. A higher ratio indicates that a company is collecting outstanding payments efficiently, whereas a lower ratio signals a need for improvement.

  • Collection Effectiveness Index (CEI): The CEI compares the reduction in outstanding receivables over a specified time frame to the actual cash collected. A higher CEI indicates that a company successfully converts outstanding invoices into cash, while a lower CEI suggests improvement in collections efforts.

5. Be proactive and accurate with collections

Consider employing automated reminders and notifications to prompt customers to pay on time. Automation software can handle this for you, freeing up time and energy for your A/R management teams to focus on more complex tasks. Use a solution that automates matching payments with corresponding invoices to mitigate disputes and facilitate accurate accounting.

6. Improve communication and the understanding of your A/R with analytics reporting

Moving your accounting system online gives you access to real-time data and analytics, enabling better decision-making and forecasting. Plus, online platforms support communication among internal teams and with customers, allowing instant access to reports and data to streamline collaboration and troubleshooting.

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All of the best practices for accounts receivable management can be facilitated with automation

Why go through the burden of manually writing invoices, distributing them, and collecting payments when automation tools can do all this for you? Manual processes can be impossible to achieve on time for businesses with a large customer base, but there is a solution. Here are ways businesses can benefit from using automation to manage accounts receivable:

  • Enhanced efficiency: Automation streamlines repetitive and time-consuming tasks, allowing staff to focus on higher-value activities and boost overall operational efficiency.

  • Reduced errors: Automated systems minimize the risk of human error in data entry, calculations, and payment matching, ensuring data accuracy and reliability.

  • Improved cash flow: Timely reminders and online payment options encourage on-time payments, leading to better cash flow management and liquidity.

  • Real-time reporting: Automation provides access to real-time data and analytics, enabling proactive decision-making, performance monitoring, and accurate financial reporting.

  • Cost savings: Over time, automation can lead to significant cost savings by reducing manual labor, paperwork, and administrative overhead.

  • Better customer experience: Automation ensures consistent and clear customer communication, enhancing their satisfaction and loyalty.

  • Enhanced compliance: Automated systems help maintain data security and adhere to industry regulations and compliance standards, reducing compliance-related risks.

By embracing automation, companies can fine-tune their financial operations and weather economic fluctuations that could otherwise set them back.

Invoiced: Automated accounts receivable management capabilities

Financial transactions are relatively simple: a customer obtains a good or service in exchange for monetary compensation. But when the customer doesn’t fulfill their part of the deal or takes a while, the business suffers, and things can get complicated. This is why implementing A/R management best practices and leveraging automation tools can mean the difference between business growth and growing debt.

Automated invoicing and collections, real-time analytics, accounting platform integration — Invoiced’s Accounts Receivable Software optimizes invoice-to-cash lifecycles for easier payment collection and management. With our open API, you can customize our solution to fit your business framework and integrate seamlessly with existing platforms.

Schedule a demo today to elevate your financial operations.

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