In some contexts, people use the terms accounts receivable and billing interchangeably. Billing is a part of accounts receivable, through which a customer is sent a physical or electronic bill. Often, billing is more from the customer’s perspective, who adds these bills to their accounting software and later issues payments.
Neither one of these departments is better or worse than another, but rather, each serves a different purpose. Accounts receivable is how a company tracks and collects money their customers owe them. Accounts payable are the funds the organization owes to others. Each side is responsible for either collecting or applying payments against open balances.
If accounts receivable are less than accounts payable, the company may be collecting cash quickly but not servicing its obligations, meaning a larger liability. However, this also means the company has access to cash sooner and is not dependent on its customers paying more quickly. If the company owes less in accounts payable, than what it is owed in receivables, this means it can expect more cash inflows in the future, but also means the company is spending more cash to pay its bills than it is collecting. It is also important to keep an eye on the amount in accounts receivable to ensure that cash is flowing back.
Accounts receivable is an asset account. They should remain in a debit balance, with a payment on them being a credit. If a sale is made, revenue is credited and A/R is debited, while an incoming payment is applied as Debit Cash / Credit A/R.
Full cycle accounting refers to the complete set of activities the accounting department must do over a reporting period. Full cycle accounts receivable is the full set of transactions associated with this business activity. For example, a customer applies for credit, is approved, buys something, a bill is generated, they are invoiced, they pay, the payment is processed.
The average collection period is the amount of time it takes to receive payments owed by your clients. This figure shows how effective your accounts receivable management practices are. A lower average collection period is ideal.
Accounts receivable days indicate how long it takes to clear all of your accounts receivable, which lets you know your short-term receiving efficiency. The accounts receivable days formula is simple. Simply take accounts receivable and divide it by revenue, then multiply it by the number of days in a year.
Days Sales Outstanding (DSO) represents the average number of days between when an invoice is issued and when payment is received from the customer. A lower DSO is better, because this means customers are paying their invoices more quickly. A higher DSO means it takes a long time to collect cash on revenue. This could create a cashflow issue if the company is spending on personnel or other bills, while not yet receiving payment from customers.
DSO is usually calculated from the past 12 months (Trailing Twelve Months, TTM) in average AR for the period. We calculate average AR by our (Ending AR balance – Starting AR balance)/(# of months). We then divide this amount by our total credit sales in the period, and then multiply by the number of days in the period (if 12 months, then 365; or a shorter period analysis).
If you are not actively, carefully managing accounts receivable, your company is in danger. AR leads to cash flow, which you need to pay debts, invest in business growth, and otherwise meet your goals. Failing to manage accounts receivable leads to issues like missed payments, unsent invoices, and ultimately, no or low cash flow.
AR’s biggest role is to bring that cash flow into the business. The department should be aware of, and watching, key performance indicators like AR days and turnover.
AR should also have a goal of maintaining accurate customer data and establishing a clear and understandable credit approval process. Ultimately, accounts receivable should have a goal of a streamlined, optimized, efficient system for payments and collections.
Accounts receivable increasing is generally not a good thing. It means that more customers are purchasing on credit and have not paid for all of the credit sales. This removes cash flow from your company’s net income, and if it gets too high, it represents a big problem.
Accounts receivable increases when more people are paying on credit and/or not paying their bills quickly. This is a drain on your cash flow and should be resolved as soon as possible.
*This blog does not constitute solicitation or provision of legal advice and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction.*