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Updated Feb 05, 2024

How to Process Accounts Receivable: A Step-by-Step Guide

Accounts receivable is the money a customer or client owes your business. Learn how the accounts receivable process works and how accounting software can help you manage it.

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Jamie Johnson, Senior Analyst & Expert on Business Operations
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Most businesses give their customers the option to pay with credit, often called “trade credit,” which provides additional flexibility for your customers. If they purchase a product or service on credit, you’ll track their pending payment in accounts receivable. 

This article will look at what accounts receivable are, as well as how your business can track and process accounts receivable payments. 

What is accounts receivable?

The term “accounts receivable” (AR) refers to the total amount of money owed to your business by its customers. This includes the money already invoiced and any credits or discounts not yet applied to invoices.

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A typical AR report shows how much revenue has been generated by invoicing clients for products or services. It can also show how much revenue is outstanding. Accounts receivable are considered assets because they represent money owed to your business.

For example, let’s say James wants to purchase a $1,200 washing machine but doesn’t have the cash at the time of the sale. The business could grant him a 45-day credit to pay for the item. During that time, the seller would list the $1,200 sale under accounts receivable on their general ledger. Once James pays the debt, the business will mark the transaction as paid. 

How to process accounts receivable

Accounts receivable processing is fairly straightforward. If you want to offer trade credit to customers, here are some steps to get started: 

1. Outline the credit terms.

Offering credit to customers can be a risky move, even for a seasoned business owner. To increase your chances of collecting your accounts receivable on time, outline your credit terms. That way, you’ll be able to evaluate each customer’s credit eligibility before you do business with them. You’ll also set the expectations for your customers from the start. 

Here are some of the terms you’ll want to explain:

  • The amount of credit you’re willing to extend to each customer
  • Your payment terms (for example, net 30 or net 60 — the number of days before payment is due)
  • Whether your business offers early-repayment discounts 
  • Penalties for late payments
  • Other criteria for customer credit 

Once you’ve outlined these parameters, consider the customer’s payment history, cash flow and value as a customer. You also may need to evaluate the terms your competitors offer. 

2. Invoice your customers.

Your business invoicing system can make or break the accounts receivable process. Your invoice is the primary way you’ll communicate with your customers, since it outlines the transaction’s details. 

Every invoice should include the following information:

  • The goods or services sold
  • The costs of the goods or services
  • The name of the customer
  • The payment due date
FYIDid you know
Always review your invoices before you send them, and follow up on pending invoice payments. Most accounting software has features that let you set up automatic payment reminders.

3. Keep track of outstanding payments.

No business owner wants to lose money, but it’s easy to overlook your accounts receivable payments. Failing to stay on top of AR results in a deficit, since you’re missing out on those expected payments. 

Tracking outstanding payments is a crucial part of the accounts receivable process. You may want to create a dedicated accounts receivable ledger highlighting your unpaid invoices and the total amount due. 

A great way to manage your outstanding payments is to use accounting software, such as QuickBooks or Xero, that tracks them for you. You’ll also be able to create an accounts payable aging report to monitor overdue invoices. [See related article: QuickBooks Desktop vs. Online]

Did You Know?Did you know
The best accounting software can do a lot more than manage overdue invoices. You can use the software to track business transactions, store customer and vendor information, and generate reports during tax season.

4. Collect the payment.

Most businesses offer payment terms between 30 and 60 days, depending on a customer’s relationship with the company. Have a process in place for collecting payments and for ensuring most customers pay on time. The longer it takes your business to collect on overdue payments, the less likely you are to receive the funds. 

Offer customers multiple payment options so it’s easy for them to pay. For instance, you could let them pay by credit card, debit card or ACH. Most companies also offer alternative payment options, like PayPal.

5.  Reconcile the payment.

Finally, once the customer has paid their invoice, reconcile the payment. An efficient reconciliation process ensures that your books stay up to date and that you’re prepared if your business is ever audited. It can also help you avoid costly financial mistakes in the future. 

Again, using accounting software is the easiest way to ensure you reconcile these payments, since it gives your business a simple, automated way to track customer payments. 

TipBottom line
Offering early-payment discounts is a great way to incentivize your customers to pay invoices quickly. You can add the early payment to the invoice or include it in the business contract.

Why is it important to track accounts receivable?

It’s important to stay on top of your business’s accounts. Let’s look at a few reasons why. 

It improves cash flow.

What would you do if you found yourself unable to pay for your business overhead, payroll or goods received from vendors? AR is a crucial step that turns your invoices into real cash. Failure to track your accounts receivable could cause cash flow problems for your business down the road. 

It aids cash management.

While sales are essential for any business, a lack of cash on hand will negatively affect your company’s ability to manage its day-to-day operations. As a business owner, you need to convert your accounts receivable faster than your accounts payable. 

This will help you generate better working capital for your business. By tracking your accounts receivable, you can efficiently collect the money owed to your company and maintain positive cash flow. 

It prevents bad debts.

When you let a customer pay on credit, there’s always the chance they won’t pay the money they owe. If enough customers default on their payments, this will affect your company’s profits. The longer a customer takes to pay, the less likely it is that your business will collect the money. Once a receivable is regarded as uncollectible, it’s written off against your gross profit.

Tracking your business accounts receivable can help identify customers who are overdue on their payments and prevent future bad debts. 

What’s the difference between accounts payable and accounts receivable?

Accounts receivable are the payments owed to a company for the sale of goods or services. AR are typically listed on a company’s balance sheet as assets and recorded whenever a business offers trade credit to its customers. 

In contrast, accounts payable represent the amount of money or credit a business owes its vendors and suppliers. Accounts payable are usually general expenses, recurring bills and operating costs. Whereas accounts receivable are recorded as assets, accounts payable are liabilities. 

For example, if your company purchases linen material, the business that sold it to you will send you an invoice. Your business owes the money, so you’ll track the bill under your accounts payable section. The vendor will record the transaction in its accounts receivable column. 

Accounts receivable and accounts payable are two sides of the same coin, and both play big roles in your business’s cash flow. Both can help you evaluate the financial health of your business at any point in time. 

The best accounting software for managing accounts receivable and payable

Accounting software is the best way to manage your income and outgoing payments and stay on top of your finances. Here are the four best options to consider:

  • QuickBooks Online: QuickBooks Online makes it easy to reconcile your expenses, send professional invoices and monitor your company’s cash flow. You can also generate detailed reports and track your company’s inventory. QuickBooks is a good option for any business owner who needs to regularly collaborate with an accountant. Learn more in our QuickBooks Online review.
  • FreshBooks: FreshBooks is an excellent option for small businesses and solopreneurs. You can use the software to send invoices, accept customer payments, and create profit and loss statements. If a customer has a question about their invoice, you can answer their questions directly through the FreshBooks app. Learn more in our FreshBooks review.
  • Xero: All of Xero’s plans allow unlimited users, and the software integrates with hundreds of third-party apps. You can send quotes and invoices, set up automated billing and bulk-reconcile your transactions. Learn more in our Xero review.
  • Zoho Books: Zoho Books offers a free plan and a wide variety of features to make it easier to manage your finances. You can use the software to send invoices, accept customer payments and manage your company’s vendors. Learn more in our Zoho Books review.

Look for creative ways to manage accounts receivable

Offering trade credit is an excellent way to build customer loyalty and increase your profits. Customers who can’t make an upfront payment may be willing to use credit, so it can be one of the best ways to expand your customer base and boost your bottom line. 

However, offering trade credit means you’ll need to stay on top of your accounts receivable process. Increasing your sales is helpful only if you can collect the money owed to your company.

Establishing credit terms, staying on top of overdue invoices and quickly reconciling payments are the best ways to create a top-notch AR process. Integrating accounting software into your accounts receivable process can also go a long way in improving your business’s financial health. 

author image
Jamie Johnson, Senior Analyst & Expert on Business Operations
Jamie Johnson has spent more than five years providing invaluable financial guidance to business owners, leading them through the financial intricacies of entrepreneurship. From offering investment lessons to recommending funding options, business loans and insurance, Johnson distills complex financial matters into easily understandable and actionable advice, empowering entrepreneurs to make informed decisions for their companies. As a business owner herself, she continually tests and refines her business strategies and services. Johnson's expertise is evident in her contributions to various finance publications, including Rocket Mortgage, InvestorPlace, Insurify and Credit Karma. Moreover, she has showcased her command of other B2B topics, ranging from sales and payroll to marketing and social media, with insights featured in esteemed outlets such as the U.S. Chamber of Commerce, CNN, USA Today, U.S. News & World Report and Business Insider.
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