A guide to accounts receivable management

A more sophisticated approach to accounts receivable management can free up working capital and drive efficiency. Here’s how to approach it.

In competitive markets or challenging economic conditions, businesses benefit from optimizing for working capital. Freeing up funds provides more financial ammunition that can be used to fuel growth or build operational resilience.

Accounts payable optimization is often the first target for businesses seeking a stronger working capital position, but it’s not the only option available. Accounts receivable optimization is another opportunity that’s well worth pursuing.

Businesses can focus on improving their approach to accounts receivable (AR) management, and in the process unlock more cash, reduce operational costs, and improve overall efficiency.

Let’s take a closer look at what the accounts receivable management process involves and how companies can manage their AR more effectively.

What is accounts receivable management?

Accounts receivable management refers to the approach taken to managing and collecting outstanding customer payments, which are collectively labeled accounts receivable. Listed as a current asset on the balance sheet, accounts receivable represents the value of all outstanding invoices.

It’s often a relatively significant figure in total but isn’t able to be deployed in operations until customers pay their invoices. Late payments can, therefore, be detrimental to the financial health of a business and its ability to capture opportunities.

The faster companies can collect payment from customers, the sooner they can use the resulting cash to cover operating costs, build resilience, generate returns from investment, or drive revenue growth.

In short, AR management is concerned with expediting the process of collecting outstanding customer payments. Done effectively, it can be just as valuable a lever as accounts payable when it comes to building a strong working capital position.

But it’s not without its challenges. Siloed or inaccessible AR data, difficulty tracking outstanding invoices, cumbersome customer communications, and time-consuming reconciliation processes can all make the AR collection process less efficient.

Fortunately, companies can address these and other challenges by practicing effective AR management. This not only improves the performance of the AR department in isolation but can also benefit the business as a whole.

The accounts receivable management process

Before moving on to methods of improving the AR process, it’s useful to first review the process itself. While the details may differ from company to company, the accounts receivable management process typically includes the following steps:

1. Establishing credit policies: The first step in AR management comes at the point of onboarding new suppliers. Establishing suitable policies that outline customer credit terms, including permissible levels of outstanding credit and favorable payment terms, makes sure that AR is primed for success.
   
   Credit policies should also detail penalty fees for late payments.If a customer has multiple late payments, consider changing your credit policy. Require the client to make a deposit before filling any future orders. In extreme cases, you may insist on full payment when the order is placed.
   
   
2. Invoicing customers: Invoicing is the first step in the accounts receivable process proper. Invoices should be accurate, clear, and easy to read, detailing the products supplied and/or work done. Invoices should also cite the agreed payment terms and due dates, as set out in the established policies. To avoid delays in payment, invoices should be sent out as soon as possible.
   
   
3. Tracking receivables: Companies should proactively track the status of their receivables in order to understand how much money is outstanding at any given time. With greater visibility, the most important payments can be prioritized. Centralized AR management systems can help to make this easier to handle.
   
   Track receivables using an accounts receivable aging schedule. The schedule groups receivable balances based on how long the invoice has been outstanding (30 days, 60 days, etc.). An aging schedule provides a snapshot of the total dollar amounts owed and how late payments are.
   
   
4. Managing disputes: When an invoice is disputed, companies need to have the right processes in place to achieve a rapid resolution. As well as helping to maintain healthy cash flow and reduce the number of due payments that get written off as bad debt, effective dispute resolution helps to strengthen relationships with customers.
   
   
5. Chasing payments: By sending reminders before an invoice is due, companies can encourage customers to pay on time. Invoices that become overdue need to be identified as soon as possible, and customers chased for payment.

How to improve accounts receivable management

The above mentioned process is full of sub-processes that can be optimized and improved to make accounts receivable management more efficient overall. There are several key ways to improve AR management, including:

Making payment terms clear

Arguably the most important part of an AR process, ensuring customers have a full understanding of payment terms and policies, can prevent issues from arising when it comes to actually settling invoices.

Payment terms should be spelled out explicitly to customers during the onboarding process, stating due dates, available early payment discounts, and any potential late fees or charges. By highlighting terms in initial agreements and ongoing correspondence – which can be referenced in the event of any dispute – companies can avoid future misunderstandings.

Using the right KPIs to measure performance

There are various key performance indicators (KPIs) companies can use to measure the general effectiveness of their approach to accounts receivable management, and to monitor the effects of optimization. Common AR metrics include:

• Days sales outstanding (DSO): DSO is widely used to measure the average number of days that a business takes to collect its accounts receivable. While standard payment terms can vary, the shorter the DSO, the faster the business collects payment from its customers.
• Accounts receivable turnover ratio (ART): The accounts receivable turnover ratio measures the average number of times that AR is turned into cash during a given period. The higher the turnover ratio, the more efficient the AR process. As such, the ratio can indicate whether invoices are being settled faster or more slowly over time.
• Collection effectiveness index (CEI): By comparing the amount collected during a period of time to the value of outstanding receivables during the period, the CEI shows how effectively a business’s AR management is converting credit sales into cash. The closer the CEI is to 100%, the greater the effectiveness of the company’s collections.
• Average days delinquent (ADD): ADD measures the average number of days that invoices are past due or delinquent at a given point in time. Unlike DSO, it is only used to evaluate invoices that have gone beyond their agreed settlement date.

Building strong channels of communication

Effective communication increases trust and the flow of information in buyer-supplier relationships, whereas ineffective communication limits it. Open communication channels allow businesses to build positive customer relationships, making it easier and simpler to chase payments and settle disputes.

Your business should have a formal collection policy that is consistently enforced. If you consistently enforce these policies, customers may pay invoices sooner to avoid your collection follow up.

Adopting a centralized digital AR management system

By implementing a centralized digital accounts receivable management system, businesses can gain more visibility over unpaid invoices and track customer performance more effectively over time. It’s important to ensure that any centralized system is accessible to all stakeholders, with appropriate controls.

Making payment simple for customers

Late payments aren’t always the buyer’s fault – the range of payment options the supplier offers can impact on-time payments too. Offering various payment options beyond simple paper-based invoicing, including solutions such as electronic invoicing and digital payment portals, makes it easier for customers to pay, thereby reducing delays.

Integrating automation

Businesses can also improve AR efficiency by streamlining the receivables management processes. Automating different parts of the process – enabling automatic invoice creation from purchase orders or sending automatic payment reminders, for example – is a quick way to improve inefficient manual processes, reduce costs, and minimize the potential for human error.

Accounts receivable financing as a working capital solution

Lastly, businesses can use accounts receivable financing to improve their accounts receivable management and support their broader working capital objectives. AR financing acts as a line of credit backed by outstanding monies owed by customers, generating working capital in return for a chosen portion of its accounts receivable.

Taulia Accounts Receivable Financing offers an efficient – and flexible – way to access cash and free up working capital without harming supplier relationships. With our innovative technology, businesses can connect with our platform, bypass the limits of traditional AR financing, and start accessing funding across the entire cash conversion cycle.

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