Understanding the Accounts Receivable Process Cycle

What is the Accounts Receivable Process?

Every business that extends credit to its customers has an accounts receivable process. Simply put, accounts receivable (AR) refers to the amounts owed to a company by its customers for products or services provided on credit.

The AR process entails a series of steps that businesses take to ensure they are collecting the payments owed to them, managing their outstanding customer balances, and minimizing the risk of non-payment.

Let’s explore the key elements of the accounts receivable process and how it affects the financial health of a business.

Key Element of AR Process: Credit Policies

One of the critical elements of an accounts receivable process is the establishment of credit policies that dictate how much credit to extend to customers, the terms of payment, and how to assess the creditworthiness of customers.

It is necessary to set these policies to reduce the risk of non-payment, minimize the amount of bad debt, and increase cash flow. The policies should also include a process for evaluating customer creditworthiness, such as running credit checks, reviewing references and credit history, and setting credit limits.

By having clear credit policies in place, a business can ensure that they are not taking on too much risk while extending credit to customers.

Stages of the Accounts Receivable Process Cycle

Invoice Creation

Invoice generation is the first stage of the AR process cycle, which involves issuing a formal request for payment to your customers for the goods or services provided. An invoice typically contains details about the transaction, such as the goods or services provided, the cost, payment terms, and due dates.

The invoice should be delivered to the customer in a timely manner to ensure that the customer can process the payment within the agreed-upon time frame. It’s also important to ensure that the invoice is error-free and contains all the appropriate information needed to process the payment. Delayed invoices might affect the ability of the business to collect payments from customers, causing cash flow challenges.  It is essential to create an accurate and clear invoice to avoid payment delays or disputes.

Payment Posting and Allocation

Once your customers receive the invoice, they make payments against it following your organization’s payment terms. The payment posting and allocation stage involves the entry of the payment details into the system to ensure the accounts’ accuracy. Allocating payments to the correct invoices is essential to avoid any missed or late payments and maintain the AR’s accuracy.

Payment Processing and Tracking

Once the customer receives the invoice, they will process the payment according to the payment terms. The payment terms stipulate when the payment is due. Common payment terms include net 30, meaning that payment is due 30 days after the invoice date.

The accounts receivable team will track and manage these payments, ensuring that the payments are received in a timely manner and correctly applied to the correct accounts. The team should also follow up with customers who may be late with their payments to ensure they will be received.

Collection

The collection stage involves the management of overdue or unpaid invoices. As part of the AR process cycle, you need to track, communicate with, and follow up with the customers until they make payments. It is essential to have appropriate collection policies, escalation procedures, and metrics to track the overdue invoices and manage bad debts.

Account Reconciliation

One of the final steps in the accounts receivable process is reconciling accounts and reporting. This step involves ensuring that all payments have been received and properly applied to the customer’s accounts. The reconciliation process is crucial to ensure that the accounts receivable balances are accurate and reflect the true outstanding amounts owed to the business.

In the account reconciliation stage, you reconcile the AR balance against your general ledger to ensure accuracy and completeness. The accounts receivable team will prepare reports summarizing the outstanding balances owed by customers. These reports can help identify customers who may require additional collection efforts, as well as provide information on the overall health of the business’s accounts receivable.

Account reconciliation helps spot any discrepancies and helps ensure that there are no unrecorded transactions that can affect your organization’s financial statements.

Reporting and Analysis

The last step in the accounts receivable process is an analysis of the accounts receivable balances. By analyzing the accounts receivable, a business can identify trends, track performance, and identify issues that may need attention.

Analysis can include calculating the days sales outstanding (DSO), which is a measure of how long it takes customers to pay their outstanding balances. A shorter DSO would indicate efficient payment collections, while a longer DSO can indicate delayed payments and the need for additional collection efforts.

The reporting and analysis stage involves analyzing the AR data to identify trends, such as the duration of time between issuing the invoice, payment receipt, and collecting overdue debts. You can use this data to make informed decisions on improving your AR management process.

How Does Accounts Receivable Process Cycle Vary Among Industries?

The Accounts Receivable (AR) process cycle can vary significantly between industries due to different business models, compliance requirements, customer behaviors, and invoicing norms. Below are some ways in which the AR cycle might differ

Manufacturing Industry

• Invoice Complexity: In manufacturing, invoices often contain multiple line items and may include details about bulk shipments, leading to complex invoice generation and reconciliation processes.
• Payment Terms: Typically long, sometimes extending up to 90 days, to accommodate production timelines.
• Compliance: Strict regulations around quality and safety often require additional documentation, affecting the AR process.
• Global Operations: Currency exchange and international payment terms can add layers of complexity.

Healthcare Industry

• Payer Mix: Unlike other industries, healthcare often has to deal with a mix of payers, including insurance companies and patients.
• Regulatory Compliance: Strict HIPAA compliance requirements influence how data is handled, including invoicing.
• Coding and Billing: The use of specific medical codes adds complexity to the invoicing process.
• Claim Denials: The AR cycle can be longer and more complicated due to frequent claim denials and appeals.

Retail Industry

• Volume and Speed: The retail industry often sees a high volume of transactions but with smaller invoice amounts.
• Point of Sale: Many transactions are completed immediately, simplifying the AR process.
• Seasonal Variability: Sales events and seasons can significantly impact the AR cycle.
• E-commerce: Online sales may introduce digital payment methods and shorter payment terms.

Software-as-a-Service (SaaS) Industry

• Subscription Billing: The SaaS industry mostly deals with recurring revenue models, requiring specialized AR software for subscription management.
• Global Customer Base: Multiple currencies and varied payment methods are often a factor.
• Upgrades/Downgrades: Changes to subscription levels can complicate the AR process.
• Churn: Customer attrition affects the predictability of receivables.

Construction Industry

• Milestone Payments: Payments are often linked to project milestones, adding variability to the AR process.
• Retainage: A portion of the payment may be held back until project completion, affecting cash flow.
• Large Invoices: The industry often deals with high-value invoices that are subject to intense scrutiny.
• Contracts: Legal complexities and clauses can delay payment cycles.

Each industry has its unique challenges and nuances that affect the AR cycle, from the simplicity and volume of transactions in retail to the complex, regulated, and often elongated processes in healthcare and manufacturing. Therefore, companies often adopt industry-specific AR software and practices to meet these unique needs.

How Can Technology Aid the AR Process?

Technology can play a pivotal role in optimizing the Accounts Receivable (AR) process, contributing to both operational efficiency and financial health. Here’s how technology can make a difference:

Automation of Manual Tasks

Order automation tools such as OrderAction can handle various stages of the AR process, including invoicing, payment reminders, and collections. This not only speeds up the cycle but also minimizes human error. A study by McKinsey found that automation can reduce transaction costs by as much as 60 to 90 percent.

Integration with Other Financial Systems

Modern AR software such as Artsyl docAlpha can integrate with other financial and operational systems, such as Enterprise Resource Planning (ERP) and Customer Relationship Management (CRM) systems. This ensures that data flows seamlessly across different departments, improving overall process efficiency and data accuracy.

Real-Time Reporting and Analytics

Advanced analytics capabilities of OrderAction AR software can provide real-time insights into payment behaviors, invoice aging, and other crucial KPIs. Such analytical tools can help businesses identify trends, forecast cash flow, and make informed decisions.

According to a Deloitte report, analytics can «provide companies with the insights they need to move from simply managing working capital to optimizing it.»

Enhanced Customer Communication

Technology can facilitate better communication with customers through automated emails, SMS notifications, and even chatbots for quick query resolution. Improved communication ensures that customers are well-informed about their payment statuses, which can significantly enhance the customer experience and encourage prompt payments.

Secure Payment Gateways

Technology can also introduce more secure and versatile payment options, making it easier for clients to settle invoices. From credit card payments to digital wallets and bank transfers, multiple payment options integrated in ArtsylPay can lead to faster collections.

Regulatory Compliance and Auditing

With ever-changing financial regulations and compliance requirements, especially in industries like healthcare and finance, AR software can help keep track of these changes and ensure that your invoicing and collection processes are compliant. For instance, features such as digital signatures and time-stamped actions can aid in auditing and compliance.

Cost Savings

By streamlining the AR process through technology, businesses can significantly reduce operational costs. Automated systems require less manual intervention, reducing the need for a large accounts receivable team and thereby lowering labor costs.

By embracing technology in the AR process, businesses stand to gain on multiple fronts, from improved operational efficiencies to enhanced customer satisfaction and regulatory compliance. Given the substantial benefits, investment in advanced AR technology is not just an operational decision but a strategic one.

Final Thoughts: The Importance of Understanding AR Process Cycle Stages

Proper management of AR is essential for your organization’s financial health. The accounts receivable process is critical for businesses that provide products or services on credit. By following the above steps, a company can manage its accounts receivable effectively, reduce bad debt, and increase cash flow. It’s important to emphasize that effective communication, clear policies, and regular follow-up and analysis can help reduce the risk of losing money on uncollected payments.

Businesses that understand the accounts receivable process can improve their financial health and ensure that they receive the payments owed to them by their customers.

FAQ

What is the Accounts Receivable (AR) Process Cycle?

The Accounts Receivable Process Cycle refers to the series of steps taken by a business to invoice customers for goods or services provided, track these invoices, and collect payment. The cycle starts when a sale is made and ends when the payment is received and properly accounted for.

How Long is a Typical AR Cycle?

The length of an AR cycle varies by industry, customer, and the specific terms of the sale. Payment terms could range from immediate payment to net 30, 60, or even 90 days, affecting the overall length of the cycle.

How is AR Different Across Industries?

Different industries have different complexities, regulations, and customer behaviors that affect the AR process. For example, the healthcare industry often deals with insurance companies and has strict compliance requirements, whereas the retail industry usually involves point-of-sale transactions that close out quickly.

What are Common Challenges in the AR Process?

Some common challenges include:

• Late payments from customers
• Invoice disputes
• Inaccurate or incomplete invoicing
• Complex regulations and compliance
• Foreign exchange and cross-border payments

What is AR Turnover Ratio?

The AR Turnover Ratio is a metric used to analyze how efficiently a company manages its accounts receivable. It’s calculated by dividing net credit sales by the average accounts receivable during a specific period. A higher ratio indicates effective credit and collection processes.

Is Accounts Receivable Considered an Asset?

Yes, Accounts Receivable is considered a current asset on the balance sheet. It represents money that is owed to the business for goods or services already delivered.

What are the Accounting Principles Associated with AR?

The AR process must adhere to accounting principles such as the accrual basis of accounting, the matching principle, and the principle of conservatism, among others. These ensure that revenue and expenses are properly matched and that the financial statements present a fair view of the company’s financial position.

By understanding the intricacies of the AR process cycle, businesses can better manage their cash flow, reduce debt, and improve financial health.