Updated: Mar 28
On the last article, we talked about the definition of Account Receivable and its importance to business. Subsequently, Accounts Receivable ought not be mistaken for Accounts Payable. Whereas Accounts Payable is the debt a company owes to its suppliers or vendors, Accounts Receivable is the debt of customers to the company.
So as to determine customers that have paid, and which payments are overdue, the business’s owner is proposed setting up an Accounts Receivable procedure.
The Accounts Receivable procedure includes 4 main steps:
1. Establishing Credit Practices
The initial step is to build up a credit application process. The company will decide as to whether they offer goods or services on credit. Payment terms and conditions are also established. The purpose is to ensure customers pay in time. Credit practices usually differ from small and large companies. Enormous companies may opt to give their customers a longer period of time. Conversely, long payment terms could affect small company’s cash flow and working capital.
2. Invoicing Customers
First, let’s figure out the differences among invoices, sale receipts, and statements.
Invoices are documents provided to the customer with detailed information about the goods or services that they bought. It includes the costs of those goods and services as well as the expired date payment.
Sale receipts are different from payments. It is only issued if the customer pays in full at the time of purchase. If the customer is going to pay later or split into multiple payments, you should issue Processing Invoices.
Statements are documents which are sent to a customer to provide several current invoices and specifies the total amount due.
Each Invoice, Sales Receipt, or Statement is required to have a unique number for easy tracking.
The customer also is given the chance to choose between paper and electronic invoices. Small firms mostly offer to use mails to deliver paper invoices whereas larger ones prefer to send both.
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3. Tracking Accounts Receivable
The company can choose whether tracking Accounts Receivable manually or using management software. You may be comfortable with an offline, manual entry system using Excel. Nevertheless, using accounting software with a receivable option could be a good experience. You can load all customers and sales information into the system. It could generate both paper and electronic invoices. You can also run reports to identify which invoices are still outstanding, so you do not need to keep separate paper documents of paid and unpaid invoices.
At the end of the month or payment period, a statement is issued to show the sums owed on past invoices in detail. It also shows payments received. After that, it calculates any balance forward that remains unpaid.
4. Accounting for Accounts Receivable
If you use accounting software, it also automates the process. When you generate an invoice in accounting software, it will automatically make an entry on your financial statements for the month. The advantage of this automation is that it spares you the time and effort of having to manually enter the same information more than once. Likewise, it reduces the occurrence of mistakes from typing different amounts of information on different reports.
Accounting for bad debts and early payment discounts also require consideration. Bad debts reflect the amount of money that is not going to be paid in the future. The correct way to account for bad debt is to make an estimate of how many invoices will not be paid and accrue that much each month in journal entries. Early payment discounts cause a different result. For each customer offered a discount for early payment, the customer will pay less than the invoice total. Then you need to record the difference as a profit reduction in the sales discount account.
Accounts Receivable Aging report also need to be prepared. This report gives you detail about all unpaid invoices. It shows how overdue your invoices are, from 0 to more than 90 days. You could use this report to estimate your bad debt accrual. Additionally, you can utilize it to distinguish invoices that require follow-up action.
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