What Is Accounts Receivable: A Practical Guide for Businesses
- Published: 3 March 2025
- 15 min read
- Running a Business, Bookkeeping
Heather Cameron
Author
From expert guidance and helpful accounting tips to insights on the latest trends in fintech, Heather is here to empower entrepreneurs and small business owners in Singapore with great content. With a background in digital marketing spanning eight years, she has experience writing for various industries and audiences. As Osome’s copywriter, she’s here to inform and inspire our readers with great storytelling.
Kelly Yik
Reviewer
Kelly Yik, our Accounting Team Lead based in Singapore, ensures that the team meets quality standards and follows accounting standards (SFRS) while remaining compliant with all the authorities' rules and regulations in Singapore. With six years of experience in Singapore accounting, she knows the ins and outs of financial reporting standards, GST, and corporate tax like nobody's business. Kelly supports our blog writers by carefully reviewing our content, making sure it's accurate, up-to-date, and packed with helpful tips for Singapore businesses. So, you can trust the info you get on our blog is not only interesting but also reliable!
Accounts receivable is the money customers owe your business for goods or services they bought on credit. This guide covers everything from what accounts receivable is, why it’s important, and how to manage it well.
Key Takeaways
- Accounts receivable represent amounts owed by customers for goods or services provided on credit and are critical for assessing a company’s short-term finances and liquidity.
- Effective accounts receivable management is essential for optimising future cash flow, enabling businesses to meet operational expenses and maintain financial stability through timely collections and reducing risks of debts.
- AR activities must be accurately recorded across different company financial documents, such as your balance sheet, monthly and periodical income statement, Profit & Loss, etc.
- Key performance indicators such as Days Sales Outstanding (DSO) and accounts receivable turnover ratio are vital for monitoring the efficiency of accounts receivable processes, helping businesses identify trends and improve financial health.
Definition of Accounts Receivable
Accounts receivable represent the amounts owed by customers for services purchased on credit. When a company delivers a product or service but hasn’t yet received payment, these unpaid credit sales are recorded as accounts receivable (AR). Typically classified as current assets on the balance sheet, the AR balance reflects the money expected to be collected in the near future, usually within a year.
AR balances can directly impact a company’s financial statements by indicating expected collections from credit sales. Measuring financial liquidity through accounts receivable provides insights into a business’s short-term financial health and operational efficiency. Essentially, they are a testament to the trust businesses place in their customers, expecting timely payments in return for the goods or services provided.
Managing accounts receivable effectively is key to maintaining cash flow. Our expert accounting services help streamline invoicing, track payments, and ensure timely collections—so you can focus on growing your business.
Importance of Accounts Receivable
Accounts receivable play a pivotal role in facilitating easier payment processes and encouraging more sales. Allowing credit in sales can boost sales volume, attract new clients, and foster long-term relationships. Writing off unlikely-to-be-collected receivables ensures that financial statements accurately reflect expected revenues and assets.
Well-managed payment collection processes can significantly enhance a company’s financial stability and growth potential.
The Accounts Receivable Process
The accounts receivable process consists of a series of steps that finance teams follow to collect the company's sales and document revenue. It demonstrates how companies track and recover the amount owed to them, providing valuable insights into the company's financial and operational efficiency.
The cash conversion cycle in the AR process has three main stages: initiating a sale, offering credit, tracking payments, and handling late payments and disputes.
Initiating a sale and extending credit
Once a customer has accepted the purchase agreement and the goods or service has been delivered, the company will send a bill to the customer detailing the sale terms and amount owed. Evaluating the buyer’s creditworthiness, especially for new customers lacking a payment history, is essential before proceeding. High-risk buyers might warrant limited purchase sizes or cash-on-demand terms. For example, a retail clothing store might offer a 30-day payment period to a department store buying merchandise on credit.
The primary objective is to extend credit to customers with the expectation of timely payment. Proper management of this process improves cash flow, working capital, and customer relationships. Clear billing procedures also help reduce errors and payment friction. For example, many businesses online do not accept cash payments and would specify accepted payment methods on their invoices.
Tracking customer payments
Track payments made by your customers to identify overdue invoices and follow up effectively. Modern accounting software can track invoices and remind businesses of payment due dates, facilitating efficient payment monitoring. Once a payment is received, it is recorded in the financial records, general ledger, income statements, balance sheets, and ERP systems to maintain accurate tracking.
An ageing schedule enables businesses to prioritise overdue invoices based on how long they have been outstanding. Centralised invoicing workflows can enhance the monitoring and forecasting of cash flows, providing greater financial transparency and flexibility.
Use AI Automation tools to match payments and accounts can streamline the accounts receivable process, making it more efficient and less prone to errors.
Handling late payments and disputes
Handling late payments and disputes is inevitable and critical for your company's finances. Invoices are commonly due within 30, 60, or 90 days, and follow-up procedures are essential when they become overdue.
If a buyer misses the payment due date, maintaining regular communication and gradually escalating the intensity of contact is crucial. Strategies to collect unpaid invoices include:
- Sending reminders
- Making phone calls
- Offering payment plans
- Employing a collection agency
- Writing off the debt
Automation software can save time on sending payment reminders and notifications, streamlining the process. Evaluating payment data allows businesses to make informed decisions regarding payment terms and credit availability. Get in touch with our experts to select the appropriate accounting plan!
Key Metrics for Managing Accounts Receivable
Key performance indicators (KPIs) provide valuable insights into a company’s liquidity and overall financial health. Some core indicators to monitor are DSOs, turnover ratios, and average balance. The former indicates unpaid balances from regular sales transactions, and the latter reflects how effectively the company clears said balances.
To identify process bottlenecks and areas of improvement more effectively, consider monitoring these KPIs through automation software, which can help identify process bottlenecks, a lack of working capital, and areas needing improvement.
Days Sales Outstanding (DSO)
Days Sales Outstanding (DSO) measures the average number of days a company takes to collect payment after a sale has been made. A lower DSO indicates faster payment, crucial for maintaining positive cash flow and a healthy balance sheet.
Regularly monitoring DSO helps businesses identify trends and implement strategies to improve cash flow and accounts receivable management.
Accounts receivable turnover ratio
The accounts receivable turnover ratio measures the collection frequency of receivables in a given period. A higher AR turnover ratio indicates higher payment collection efficiencies and quicker payments, whereas a lower turnover ratio may suggest inefficiencies in collection or customer payment issues.
The turnover ratio is calculated by dividing the annual net credit sales by the average accounts receivable. The average accounts receivable balance is calculated by dividing the sum of starting and ending receivables over a set period of time (generally monthly, quarterly or annually) by two.
It’s a good time to start a business
Our Singapore-based team will break down all you need to know about incorporation, tax, and compliance as a new business owner. Book a call now.
Ageing schedule
An accounts receivable ageing schedule is a report that categorises unpaid customer invoices by due dates. This schedule helps businesses prioritise their collection efforts and maintain financial health by categorising receivables by time outstanding.
Automation in accounts receivable management can significantly improve the tracking and management of accounts receivable, enhancing cash flow and operational efficiency.
Risks Associated with Accounts Receivable
Managing accounts receivable involves several risks that can negatively impact a business’s cash flow and overall financial health. Inefficiencies in managing accounts receivable can lead to significant cash flow challenges, affecting a company’s liquidity and ability to fund operations.
The main risks include cash flow issues, doubtful debts, and increased collection costs, each of which requires careful management and mitigation strategies.
Cash flow issues
Delays in payouts can significantly disrupt the expected inflow of cash, leading to cash flow issues. For instance, manufacturers often face lengthy payment terms from large retailers, which can result in accounts receivable challenges. Medical clinics frequently encounter delays in receiving payments from insurance companies, which can deteriorate the value of receivable accounts and impact a company’s financial health.
Receivables financing can significantly enhance a company’s liquidity by providing immediate access to funds. Utilising factoring allows companies to improve cash flow while shifting collection responsibilities to a third party.
Common reasons for customer late payments include inefficient payment processes, invoice issues, and financial instability. Longer payment terms can create cash flow issues for small suppliers who heavily rely on getting paid on time.
Bad debts
ARs represent the money customers owe for products or services purchased. Writing off uncollectible debts as bad debt expenses can lead to revenue overstatement and only becomes necessary when a customer definitely won't pay. Conducting regular risk assessments helps in understanding a client’s creditworthiness and managing potential bad debts effectively.
It is recommended to monitor AR quality on at least a monthly basis. Keeping a record of doubtful accounts helps companies assess potential losses from unpaid invoices. In the worst-case scenario, companies may sell unpaid debts at a discount to collection agencies to recover some value. Also, sometimes small businesses might receive tax refunds for some debt write-offs, so use it wisely as a strategy.
Allowance for doubtful accounts
Allowance for doubtful accounts is another essential accounting tool that helps a business navigate the risks of debt and late payments. An allowance account is a general ledger account that nets against the total receivables presented on the balance sheet.
Increased collection costs
Failure to address overdue accounts can lead to significantly higher collection costs, further impacting profitability. Collection costs are incurred when businesses pursue overdue payments from customers. Timely collection efforts can help mitigate rising costs associated with overdue payments, preserving profitability.
How To Improve Accounts Receivable
Optimising the AR process reduces bad debt risk and strengthens customer relationships. Companies can improve cash flow by offering early-payment discounts and streamlining invoicing and collection processes.
AR Process automation in accounting software reduces human error and enhances data integrity, while data analytics can identify trends and areas for improvement. Regularly reviewing collection policies helps businesses adapt to changing needs and market conditions.
Setting clear payment terms
Payment terms refer to the agreed date by which a customer must pay, helping manage cash flow effectively. Determining factors include the company’s industry, its cash needs, trust in the client, and overall creditworthiness. When setting payment terms, make sure you specify due dates, late payment interests, and early payment bonus discounts. In manufacturing, payment terms often range from 30 to 60 days, with various billing cycles depending on the retailer.
Clear payment terms can help ensure a smooth cash conversion cycle and reduce debts and late payments. For example, a purchase agreement detailing specific credit terms and payment deadlines ensures all parties are on the same page. This clarity helps businesses manage their cash flow more effectively and maintain healthy customer relationships.
Using automated accounting software
Automated accounting software can automate routine tasks, such as invoicing and payment reminders. This allows businesses to reduce human error and enhance data accuracy, allowing employees to focus on more strategic challenges rather than monotonous tasks, improving overall efficiency and effectiveness.
These tools also automate data sourcing, ensuring relevant data matches across documents, reducing disputes and streamlining the accounts receivable workflow.
Expert accountants on your side
Our local team of experts helps founders get their set-up, taxes and paperwork right from the start
Conducting regular credit checks
Conducting regular credit checks is essential for mitigating risks associated with giving customers credit for purchases. A documented credit policy should guide the assessment of a customer’s creditworthiness before extending credit. Involving the finance department ensures a thorough evaluation of a client’s ability to pay on time, helping to prevent bad debts and maintain the company’s financial health.
Regular credit assessments on customers help identify potential issues early, allowing businesses to take proactive measures to protect their cash flow.
Real-World Examples of Accounts Receivable
Real-world accounts receivable examples provide practical insights and context for understanding accounts receivable management. By examining how different industries handle accounts receivable, businesses can gain valuable lessons and apply best practices to their own processes.
Let’s explore how accounts receivable are managed in the manufacturing, healthcare, and retail sectors.
Manufacturing
In the manufacturing industry, accounts receivable account for the amount owed to manufacturers for goods sold on credit under formal agreements. Typically, manufacturers enter into contracts with buyers, securing deals at an agreed price and establishing structured payment terms. Payments are often made in multiple tranches, tied to project milestones, with each tranche having payment terms ranging from 60 to 90 days or more, depending on the agreement.
Tracking these receivables requires diligent monitoring to ensure payments are received according to the agreed schedule. Proper management of accounts receivable contributes to cash flow stability, customer satisfaction, and overall business sustainability.
Healthcare
In healthcare, accounts receivable include both patient invoices and reimbursements pending from insurance companies. For example, a clinic records accounts receivable for services rendered to patients and bills their insurance companies for payment that is pending.
Medical clinics typically categorise these billed amounts as accounts receivable until the payment is received, which is crucial for maintaining the clinic’s financial health and ensuring the company's sustainability.
Retail
Effectively managing accounts receivable is crucial in the retail industry for maintaining healthy cash flow and operational stability. Retail businesses often extend credit to customers or department stores, necessitating prompt collection to invest in inventory and growth opportunities.
For example, a retailer might use automated systems for invoicing to track payments and outstanding balances with department stores more efficiently, thereby enhancing customer satisfaction and supporting the business strategy
Accounts Receivable vs. Accounts Payable
Understanding the distinction between accounts receivable and accounts payable is fundamental for maintaining an accurate accounting system and effective cash flow management. While accounts receivable represent money that customers owe for goods or services provided, accounts payable indicate money that the business owes to suppliers.
Both are essential for understanding a company’s liquidity and overall financial condition.
Definitions and differences
Accounts receivable consist of the funds customers owe for goods or services that have already been delivered. However, these payments have yet to be received. In contrast, accounts payable represent money that the business owes to suppliers for goods or services received.
In a transaction, the seller records an AR, while the buyer records an accounts payable (AP). Both accounts are reset to zero on the balance sheet when the customer pays. This distinction is crucial for accurate financial records and effective cash flow management.
Impact on cash flow management
Balancing accounts receivable and accounts payable is essential for effective cash flow management and maintaining relationships with both customers and suppliers. A typical accounts receivable to accounts payable ratio considered healthy is 2:1. An imbalance, such as a 1:1 ratio, introduces a financial risk of losing money if clients do not pay as agreed.
Aspect | 📥 Accounts Receivable (AR) | 📤 Accounts Payable (AP) |
|---|---|---|
| 📖 Definition | Money owed to the business by customers for goods or services provided on credit. | Money the business owes to suppliers for goods or services received. |
| 💰Financial Role | Representsincoming cash(📈 asset). | Represents outgoing cash(📉 liability). |
| 📝 Recorded By | Seller(as an asset on the balance sheet). | Buyer(as a liability on the balance sheet). |
| ⚖️ Impact on Cash Flow | Late payments can affect liquidity. | Making payments on time maintains supplier relationships and prevents penalties. |
| 📊 Healthy Ratio | Typically managed at a 2:1 ratio compared to accounts payable. | A balanced approach ensures financial stability. |
Therefore, managing both accounts carefully ensures the company’s financial health and stability.
Tools and Technologies for Accounts Receivable Management
Modern tools and technologies have revolutionised accounts receivable management, offering automation and real-time insights that enhance efficiency and accuracy. Automation platforms reduce the delays common to manual oversight and allow employees to focus on strategic challenges rather than routine tasks.
Cloud-based ERP systems
Cloud ERP systems facilitate real-time data access, allowing for timely financial decision-making. Accessing finance data anytime and anywhere is a key advantage of cloud ERP systems for accounts receivable management.
Integrating cloud ERP with accounting software enhances data management and operational efficiency by keeping your accrual accounting and current asset data up to date at all times, allowing more effective AR management and informed decision-making.
Receivables financing solutions
Receivables financing solutions provide immediate cash access by leveraging outstanding invoices. These solutions are particularly valuable in times of financial challenges, allowing firms to immediately increase current assets to maintain regular operations.
Factoring, which involves selling accounts receivable to a third party at a discount, can alleviate the burden of managing collections while providing the necessary funds to sustain business activities. Utilising financing solutions can improve liquidity, stabilise the company's cash flow, and allow businesses to invest in growth opportunities.
Summary
In summary, accounts receivable is a critical component of business finance, impacting the company's finances and operational stability. By understanding the definition, importance, AR process, key metrics, risks, and best practices, businesses can optimise their accounts receivable management and ensure sustainable growth. Real-world examples from the manufacturing, healthcare, and retail sectors provide practical insights into effective accounts receivable practices.
Embracing modern tools and technologies, such as cloud-based ERP systems and receivables financing solutions, can further enhance accounts receivable management. By implementing these strategies and leveraging the right technologies, businesses can reduce bad debts and achieve financial success. Stay proactive, stay informed, and watch your business thrive.
FAQ
What are the alternative procedures for accounts receivable confirmations?
Alternative procedures for accounts receivable confirmations are used when customers do not respond to confirmation requests during an audit. These may include reviewing subsequent cash receipts, balance sheets, invoices and shipping records, and historical payment patterns. Auditors use these procedures to verify the existence and accuracy of receivables without direct customer confirmation.
What does an audit of accounts receivable involve?
An audit of accounts receivable ensures that recorded receivables are accurate, valid, and collectable. The process includes confirming balances with customers, reviewing invoices and contracts, analysing ageing reports, and assessing allowances for doubtful accounts. Auditors also check compliance with accounting standards and internal controls to prevent misstatements or fraud.
How is the average investment in accounts receivable calculated?
The average investment in accounts receivable is calculated by taking the sum of the beginning and ending accounts receivable balances for a period and dividing it by two:
Average AR = (Beginning AR + Ending AR) / 2
This metric helps businesses analyse liquidity and credit management efficiency, often used in accounts receivable turnover ratio calculations to assess how quickly receivables are collected.
What is the cost of factoring accounts receivable?
The cost of factoring accounts receivable depends on factors such as the factoring fee, discount rate, and risk profile of the receivables. Typically, factoring fees range from 1% to 5% per month, with lower rates for businesses with high creditworthy customers. Convert receivable accounts into immediate cash to improve your company's cash flow, but be aware that this will reduce the total amount received due to service charges.
Is accounts receivable a cash equivalent?
No, accounts receivable is not a cash equivalent. While it represents money owed to a company, it is not immediately available like cash or highly liquid investments. Cash equivalents include assets like money market funds, treasury bills, and short-term government bonds, which can be quickly converted into cash with minimal risk.
Get expert tips and business insights
SubscribeWe’re using cookies! What does it mean?