Farwah Jafri | September 8 2021
If you are a small business owner who intends to switch from cash to credit method of selling, be prepared to deal with concerns like “what’s the credit sales amount you need to receive? From whom? And when?”
So, what is Accounts Receivable (AR), what involves the accounts receivable process and how does it impact your overall cash flow? Let’s take a closer look at each of these questions.
In simpler words, AR is the money yet to be collected from the customers for the goods and services you sold to them on credit. This outstanding amount or debt you owe from your clients represents a credit line due within a relatively short time frame, ranging from a few days to a year. The amount of time or term to pay the amount owed is often 30, 60, or 90 days post invoice received by the customer.
To better understand the accounts receivable process, let’s consider an example of XYZ Paints Pvt. Ltd., making wall paints and enamel. Company ABC places a bulk order of 100 containers at the rate of $20 each container to Company XYZ.
It generates an invoice of $2000 with the condition of 90 days credit period, which means that the company ABC has to pay back the due amount to XYZ Paints Pvt. Ltd within 90 days.
As soon as the paint containers are delivered to company ABC, the sale is recorded in the books of company XYZ, but the amount due is treated as accounts receivable until Company ABC pays it off.
When the payment is cleared in full, the amount received will increase the cash account by $2000 and decrease the accounts receivable by the same amount.
Here are some of the common things you will see in the accounts receivables process followed generally by most businesses.
|31-July-21||Accounts Receivable- XYZ Ltd.||$ 3000.00|
|To record the sale on account|
|Accounts Receivable- XYZ Ltd.||$3000.00|
|To record collection of receivables|
If you are offering any cash discount for early payment, make the said adjustment to the receivables account as follows:
|Sales Discounts & Allowances||$20.00|
|Accounts Receivable-XYZ Ltd.||$3000.00|
|To record collection of receivables within the discount period|
However, if the customer doesn’t pay you back within the due date, you will:
As it converts into cash once the payment is received, accounts receivable are classified as assets on the balance sheet. Usually, it is listed among current assets. However, if the business runs a credit cycle that is more than a year, it’s considered a long-term asset.
The accounts receivable process involves great risks. No matter how much trust you may show in your customers based on their credit rating, there will be someone who would delay, reduce, or miss the payment. You may also come across fraud cases where the customer has no intention of ever paying the seller. If your collection efforts don’t prove fruitful, you will need to write off the receivable as bad debt. This leads the businesses to incorporate the following essentials in the accounts receivable process:
In the light of the above, let’s discuss the following cases that you may have to deal with in an accounts receivable process:
Let’s say your forecasted sales for the year comes around to be $100,000, and as per your estimates for the uncollectible, it’s most likely that you may not collect 2% of accounts receivable. That’s to say $ 2000 ($100,000 * 0.02) are your estimated bad debts.
You would credit $2000 to “allowance for uncollectible accounts,” and debit “bad debt expense” by the same amount:
|30-Sep-21||Bad Debt Expense||$ 2000.00|
|Allowance for uncollectible accounts||$2000.00|
The estimate of the bad debts leads us to net accounts receivables.
Net accounts receivables are the total money owed to a company by its customers minus the money owed that will likely never be paid. In the above case, net receivables equal 98% (100% – 2%) of the accounts receivable (AR).
See Also: How To Calculate Net Income
Let’s say you sent an invoice of $1000 to your client, Fable Computers Inc. However, after chasing them having sent multiple reminders at regular intervals for a long time when you are convinced that you will not be paid for your products sold or services offered, you would eventually have to write it off as bad debt.
In your journal, you’d debit “allowance for uncollectible accounts” for $1000 to decrease it by $1000.
|30-March-22||Allowance for uncollectible accounts||$ 2000.00|
|Accounts Receivable-Fable Computers Inc.||$2000.00|
Let’s assume, after writing off the receivable as bad debt, you finally get the payment check of your receivables worth $1000 from Fable Computers Inc. How will you record this transaction?
To get the written-off receivables on your books, you’d do the same entries as you had done the first time to record the particular sale account. That is to say, you would first debit “accounts receivable—Fable Computers Inc.” by $1000 again and credit sales revenue by $1000.
|31-July-22||Accounts Receivable- Fable Computers Inc.||$ 1000.00|
Finally, you would record the cash payment by debiting your “cash” account by $1000 and credit “accounts receivable—Fable Computers Inc.” by $1000 again to mark the end of the account receivable process for this particular account.
|Accounts Receivable- Fable Computers Inc.||$1000.00|
|To record collection of receivables|
Businesses generally extend a credit facility to encourage customers to get the goods and services as and when needed even if they can’t pay now. This helps you get your business up and earn customer loyalty.
Besides, AR also helps businesses to stay competitive in the marketplace. If your competitors are making sales on credit, you must do the same. Otherwise, you are likely to lose your customers to your competitors.
Having a broad customer base is terrific. However, the reality is that customers don’t always pay on time, and as a result, receivables which form a major source of cash inflow for a company, adversely affect the company’s liquidity. Not being paid the cash you were expecting to receive can create a cash crunch to pay your bills, employees, and suppliers during a specific period and it will eventually create issues in your accounts receivable process.
Need help managing your accounts receivable process? Monily offers expert outsourced bookkeeping and accounting services to help you keep up with the accounts receivable process. To learn more about the accounts receivable process and how its management can help your company, contact our bookkeepers today and get a free consultation on accounts receivable solutions unique to your business needs that will help boost profitability.
Farwah is the Product Owner of Monily. She has an MBA from Alliance Manchester Business School, UK. She is passionate about helping businesses overcome challenges that hamper their growth, which is why she is working at Monily to facilitate entrepreneurs to efficiently manage business finances and stay focused on growth.