Free cash flow is tougher than ever to maintain currently. This holds strong, especially for companies in the spectrum of high growth or those that operate with low margins.
Getting your accounts receivable (AR) in control is one of the fastest ways to improve cash flow, reduce inefficient spending, and forecast with higher confidence.
Here’s where accounts receivable management fits into the picture. And it plays a crucial role.
It influences your ability to collect money, meet financial commitments, and boost working capital.
But it's not just about sending invoices to customers and hoping for the best; it's more of a strategic game that requires planning, smart work, and a good understanding of your financial situation.
Getting your AR management right is crucial. In this detailed guide, we'll dive right into managing your AR and provide the know-how and tools to supercharge your cash flow and considerably minimize possibilities of bad debt expenses.
What is Accounts Receivable Management?
Accounts receivable management, also known as debtors' management, is keeping a close eye on outstanding invoices and accounts receivable to make sure you get paid by customers or clients on time.
Why is it important?
From being able to maintain smoother cash flow to boosted financial strength, here are key reasons why accounts receivable management is important for companies:
- Smoother cash flow. Effective receivables management helps ensure steady money inflow. Having more cash helps handle payables, invest more money into the company, and act on new business opportunities.
- Reduced bad debt. By staying on top of customer payments, you reduce the risk of delayed payments and bad debts as a result. In other words, AR management can help cut down on unpaid invoices that can hurt your bottom line.
- Highly accurate forecasting. Get deeper visibility into outstanding receivables, what’s been collected, and its aging for accurate cash flow forecasting.
- Save money on interest costs. On-time payments help reduce bad debt backlogs, and interest incurred on debts required to maintain working capital.
- Better resource allocation. Better AR management helps allocate collection efforts to the right accounts and automates a big chunk of collections. This helps cut down resource requirements, ultimately improving collector efficiency.
- Saves time spent on grunt work. Managing your AR by automating your processes helps your collectors save more time and instead focus their efforts on maintaining customer relationships or following up.
- Improved customer satisfaction. Clear communication about invoices and payments directly correlates to better customer relationships.
Accounts Receivable Management Process: How it Works
While the specifics could vary, the accounts receivable process in most companies can be applied anywhere. Its goal is to get your accounts receivables in order right down to the nitty-gritty to ensure you can effectively manage what you’re owed.
- Setting credit rules: Have a set of rules in place for credit. Decide things like how much credit a customer can get and the time they have to pay. Let your customers know what these rules are.
- Credit checks: Before giving anyone credit, it's a good idea to check if they're reliable with payments.
- Payment terms: Make sure you're clear about when you expect to get paid. This can be something like "NET30.”
- Getting and recording payments: When you get paid, record it. This helps keep track of what's still outstanding.
- Checking late payments: Regularly look at a list of overdue payments. This helps you spot who's behind on paying you.
- Logging PTPs: Whenever your customer gives you a promise-to-pay (PTP) at a specified date, record it. It’s a good reference to have when you have to start following up.
- Collection follow-ups: If payments are late, it's time to nudge customers with reminders, statements, and maybe some friendly collection calls. You could also work out payment plans or negotiate settlements.
- Stakeholder involvement: Finance and AR teams cannot spearhead payment follow-ups all the time. Sometimes, your customers could have a different contact from the company such as a salesperson or a customer success manager. Understanding when to involve a particular stakeholder for better context is crucial.
- Solving disputes: If a customer has an outstanding dispute, work with them to sort it out. Good customer relations are important.
- Matching payments: When you get payments, make sure they match up with the right invoices. This can get tricky, especially for big companies, so careful record-keeping is vital.
- Reporting and analysis: Regularly look at reports and data to spot trends and see what you can do better. This helps you make smarter decisions.
Common Accounts Receivable Management Challenges
AR management comes with its fair share of challenges, right from the moment you request payment from your customers to when they finally make it. There are many intricate moving parts between these two stages such as prioritizing accounts, following up, resolving disputes, logging PTPs, and even matching payments.
You need to address these to maintain financial health and improve your overall AR efficiency.
- Delayed payments: First up, getting customers to pay on time is like herding cats. It is challenging when you have multiple customers who have not paid yet. At this point, it becomes difficult to prioritize who to reach out to and log payments as they get made.
- Credit worries: Setting credit terms is a gamble. You've got to set them carefully and ensure customers stick to it, or there could be further delays. For example, a commonly used payment term is NET30, which means customers have 30 days to make the payment from the invoice issue date.
- Unresolved disputes: Customers might argue about their issues with their product, discrepancies in bills, or even reverse charges. These can be real time-eaters.
- Sloppy data: Mistakes in your invoices, records, or data entry can lead to headaches, delays, and unhappy customers.
- Poor customer relationships: Trying to collect money without ruining relationships can be a tightrope walk. You don't want to be too pushy, but you can't be a pushover either.
- Poor stakeholder visibility: When multiple stakeholders need to be involved in the collections process, providing customer context and other details could be difficult. In some cases, this could lead to repeat follow-ups or accidentally engaging with a disputed customer.
- Matching payments: Figuring out which payment goes with which invoice can be a real puzzle (more so, if done manually), especially if you're dealing with many transactions.
- Dealing with old debts: As debts get older, collecting them can get even trickier. You'll need a game plan for these long-overdue accounts.
Accounts Receivable Management Performance
Receivables management performance measures how effectively and efficiently a company manages its outstanding receivables and collections. It reflects a company’s ability to optimize its AR processes to eventually reach its financial goals.
You can assess your receivables performance by employing a range of AR metrics and KPIs.
DSO (days sales outstanding) is a fundamental metric that measures the average number of days it takes to collect payments after a sale. A lower day sales outstanding indicates more efficient AR management.
Formula: DSO = (Average AR / Total credit sales) x Number of days
AR aging reports categorize outstanding invoices by the number of days they are overdue (for example, current, 1-30 days, 31-60 days, 61-90 days, and over 90 days). Analyzing AR reports helps identify trends and potential issues in your AR.
AR Turnover Ratio
The accounts receivable turnover ratio measures how many times a company's receivables are collected or "turns over" during a specific period. A high AR turnover ratio is considered better.
Formula: AR ratio = Net credit sales / Average AR
Collection Effectiveness Index
CEI assesses the effectiveness of the collections process in recovering overdue payments. A higher CEI indicates better performance.
Formula: CEI = (Beginning AR balance + credit sales - ending AR balance) / (Beginning AR balance + Credit sales - Ending AR balance + Current period overdue amount)
Bad Debt Percentage
This metric calculates the percentage of total outstanding AR that is not expected to be collected. A lower value is preferred, as a lower one would increase chances of a bad debt write-off.
Formula: Bad debt percentage = (Bad debt expense / Beginning AR balance) x 100
Current AR Percentage
This measures the percentage of AR that is current, indicating how well your customers are adhering to payment terms. A higher rate is better.
Formula: Percentage of Current AR = (Current AR / Total AR) x 100
Customer Satisfaction Survey
Customer feedback on their experiences with your AR processes can be an indirect measure of AR management performance. Satisfied customers are more likely to pay on time.
Monitor the number and percentage of disputes that remain unresolved, as unresolved disputes can delay payments and hinder performance.
Credit Risk Assessment
Evaluate the accuracy of credit risk assessments by comparing expected vs. actual payment behaviors of customers.
Accounts Receivable Management Best Practices
With underlying receivables challenges, getting the “management” aspect of it right can be a tough, tough nut to crack. However, AR has been around for decades, and hence there have been lots of learnings and wisdom you can quickly adopt.
Here are some accounts receivable collections best practices to keep in mind:
- Credit rules transparency: Make sure your credit policies, like who gets how much credit and when they need to pay, are easy to understand and consistently applied.
- Understand customers better: Before you offer credit, check out your customers' payment history and financial situation.
- Prioritize and segment accounts: Which customer would you follow up with? One that has delayed their payment for 30, 60, or 150 days? The art of getting this right comes down to effective account prioritization.
- Automate and personalize follow-up cadences: Following up with lots of customers who have delayed payment can be an arduous task. Plus, you wouldn’t want to send the same old email template you sent to everyone, right? Automating your follow-ups can provide breathing space for your collectors and personalizing it ensures an increased likelihood of the customer opening and replying to your email.
- Provide a customer portal: Never leave your customers in doubt. If they had to choose between checking in with you about invoice queries or being given a way to do it on their own, most would edge towards the latter. Providing self-service capabilities to your customers through a customer portal can help solve this.
- Ensure multi-stakeholder context: One of the biggest challenges in AR is when there are various stakeholders involved. Sheets, notes, or Slack messages just won’t cut it. Make sure anyone, from any team, can jump right in, understand what they need to do, and perform their tasks.
- Be clear about overdue: Check those aging reports regularly to see which accounts are getting stale. It helps you decide where to focus your efforts.
- Cash flow forecasting: Keep an eye on your cash flow to predict when you'll need more cash and when you might have extra.
How AR Automation Fits Into the Picture
Automating your accounts receivable process can help you focus on what matters most, while the nitty-gritty are handled by the system.
Collections automation makes your life easy. Here are the benefits of implementing accounts receivable automation in your company:
- Proactiveness, powered by AI: What if you could spot risky accounts or invoices before they become, well, risky? AR automation software helps you spot these trends way before it happens to help you take proactive actions to prevent it from ever happening.
- Top-down visibility: Whether your CFO wants to gauge where your cash flow is at, or your collectors want to decide which invoice to focus on, AR automation provides both a zoomed in and zoomed out view of your receivables.
- Collections with minimal manual intervention: Accounts receivable software helps send reminders, statements, and collection emails like clockwork, so you don't have to chase them down manually. Easily start, stop, or pause your sequences, change strategies on the go, or even change collection owners based on bandwidth.
- Collaboration with customer-facing teams: An accounts receivable automation software helps bridge the gap between different teams such as finance, sales or even customer success. It goes one step further by integrating with multiple relevant tools to act as a single source of truth for all context.
- Fits right into your existing tech stack: Sales, customer success and your existing financial tools - AR automation sets up nicely with what you're using so you don't have to juggle between multiple tools. Plus, your teams won't be burdened with manual data entry since everything synchronizes in real-time.
- Deep AR analytics and insights: Let's face it - data insights > plain ones. With AR automation, you get detailed reports and analytics into your AR, cash flow, DSO, and other key metrics so you can spot trends and know which accounts or invoices need your attention.
- Scales along with you: It scales along with your company as you grow, regardless of whether you have only a few clients or many. AR automation keeps up without breaking a sweat.
- Drive better customer relationships: Being proactive and personalizing your reach outs can help you overhaul your customer relationships. Your clients will love the ease of doing business with you, since AR automation makes their experience top-notch.