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How to Set Up (And Optimize) Your Accounts Receivable Process

By Nick Zarzycki on July 3, 2018

Fixing your accounts receivable process can mean the difference between having lots of cash on hand and constantly begging your friends and family for short-term loans.

But what exactly does an efficient accounts receivable process actually look like? And what can you do to improve your existing processes? Here’s where to start.

What is accounts receivable?

“Accounts receivable” (AR) refers to all the payments your company will receive in the future from customers who have made purchases from your company in the past on credit.

If you’ve ever delivered a product or service to a customer before getting paid, and then told that customer to pay you within a specific number of days, then congratulations: you have an accounts receivable process!

What an efficient AR process looks like

A well-functioning AR process will let you record sales, generate invoices, and collect payments promptly, while keeping close track of your customers’ outstanding payments.

If everything is going smoothly, your AR process should clearly communicate to customers when bills are due, minimize errors and discrepancies in payments, and provide your business with a steady, predictable cash flow.

These days, an efficient AR process will usually be a digital one, using accounting software to automate as much of the process as possible (including invoicing, tracking payments, and sending regular billing reminders).

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Common problems with AR, and how to fix them

Tackling any problems in your AR process can seem tedious or overwhelming, but ignoring them can (literally) cost you in the long run.

Here are some problems you should look out for in an AR process that isn’t functioning at its full potential, and what you can do to fix them:

Prevent data entry errors

You’d be surprised by how often companies let bad data derail their AR process. Incorrect addresses, inaccurate payment information, special payment terms and inappropriately applied discounts can wreak havoc on an AR process, delaying payments for months at a time.

Scheduling time every week to scan your AR records for errors and exceptions can nip data entry problems in the bud, and save you from headaches down the road.

Develop a crystal-clear credit policy

When you’re starved for sales, it can be tempting to loosen up the rules you have in place for extending credit to your customers (also known as your credit policy). Don’t. Loosening your credit policy is a short-term fix, usually causes more problems than it solves, and can take your company down a slippery slope.

Instead, develop crystal-clear guidelines for when you can and cannot extend credit to your customers, and don’t hesitate to enforce them, even if it means turning down a few customers in the short-term.

Vetting new customers, requiring deposits on large orders, and instituting interest payments for late payments can help you avoid bad customers in the long run. When a new customer signs up and sees the terms, they’ll understand from the get-go you’re serious about getting paid.

Be proactive when you bill customers

If you don’t bill your customers promptly, communicate payment terms to them clearly, and follow up with them about payments regularly, the chances of them paying you on time (or at all) go down drastically. It’s that simple.

Be proactive in collections

Collecting overdue payments from customers can be unpleasant. So unpleasant that companies will often put off the task, sometimes for months at a time. But not having a consistent, methodical process for collecting late payments can create huge problems down the road.

If a customer is behind on their payments, there’s no need to immediately hire a collections agency. But it’s also important to be proactive. On the day that their payment becomes past due, follow up with the customer and remind them of the late payment.

If it becomes clear that they can’t make the payment in full immediately, establish a payment plan that works for both of you. Be fair but firm, and don’t let overdue payments linger. Being proactive about late payments sends a signal to customers that you take payments seriously and puts pressure on them to act quickly.

Don’t become dependant on one customer

Let’s say one of your customers goes bankrupt and can’t make their payments. What then?

Like all the other forms of debt, it’s good to be diversified when it comes to AR. If one of your customers represents more than ten percent of your outstanding payments, you could be over-exposed to default risk.

How to get your customers to pay you faster

After you’ve patched up any obvious problems, improving your AR process will mainly involve finding ways to get your customers to start paying you faster. Here are a few ways to make the payment process easier for both sides.

Give them a financial incentive

One way to get people to pay you sooner is to make it worth their while. Offering them a discount for paying their invoices early—5% off if you pay within 5 days, for example—can get you paid faster and decrease your customer’s costs.

Make the payment process easier

One reason why your customers might be paying you later is because your preferred payment method is different from what they’re used to dealing with. You might be used to getting bank transfers or cheques, but they might be used to paying all their suppliers in Bitcoin.

Ask your customers which payment methods they prefer and do whatever you can to accommodate them.

Ask them to pay faster

It’s common for companies to offer their customers “net-30” payment terms—that is, to offer them 30 days to pay their bills. But no company is required to give their customers net-30 terms. Implementing net-15 or net-10 (15 or 10 days, respectively) instead could be enough to get them to start paying sooner.

Develop good relationships with your customers

While crystal-clear ground rules are important when it comes to AR, don’t forget the human element. If you develop healthy relationships with your customers, they’re more likely to go out of their way to maintain those relationships.

If a customer likes you, they’re more likely to pay you faster, and more likely to let you know far in advance if they can’t make their payments on time. Customers that are strapped for cash are also more likely to pay companies that they have good relationships with first, before paying anyone else.

Bill your customers electronically

Another way to cut down on paperwork and AR headaches is to start billing your customers electronically. Most companies these days have the ability to receive and process electronic invoices, and doing so can help cut down on errors and make payments faster.

Accounting software further cuts down on AR headaches by giving you the option of automating most of the process. Software like Freshbooks have the ability to schedule invoices, send automatic billing reminders, and automatically generate reports about your customers’ accounts.

How to collect delinquent payments

Let’s say you’ve set up a payment plan with a customer that didn’t pay their bills on time, and you still haven’t received your money. At this point you might be considering turning their account over to a collections agency.

Before deciding whether or not to hire a collector, contact the customer and give them one last chance to make their payment. Collections agencies often take a huge cut of the collectable amount—sometimes as much as 50 percent—and are usually only worth hiring to recover large unpaid bills. Unless the collectable amount represents a substantial percentage of your AR, coming to some kind of agreement with the customer is almost always the less time-consuming, less expensive option.

If you do end up hiring a collector, be wary of the associated costs. In some extreme cases, companies will also sue their customers for unpaid debts, with the intention of seizing their assets through a court order.

When to call something ‘bad debt’

If the costs of collecting the debt start approaching the total value of the debt itself, it might be time to start thinking about writing the debt off as bad debt—that is, debt that is no longer of value to you. Bad debt can also result from a customer going bankrupt and being financially incapable of paying back their debts.

The IRS says that bad debts include “loans to clients and suppliers,” “credit sales to customers,” and “business loan guarantees,” and that a business "deducts its bad debts, in full or in part, from gross income when figuring its taxable income.”

The IRS’s Business Expenses guide provides detailed information about which kinds of bad debt you can write off on your taxes.


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This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.

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