person sitting at desk with laptop and calculator
Accounts receivable, like accounts payable, is a vital aspect to track in order to ensure a business's financial health. — Getty Images/AndreyPopov

Accounts receivable is a crucial part of a company’s balance sheet, identifying incoming money owed to a business for products sold or services rendered.

As a business owner, you’ll want to ensure you’re keeping tabs on your pending invoices and assets. To help you learn more about setting up and maintaining your business’s accounts receivable, we defined and outlined the process.

What is accounts receivable?

Your accounts receivable consists of money or credits owed to your company by its customers and clients. It is considered an asset rather than a liability, because it is an amount you are gaining rather than losing.

Accounts receivable is typically tracked with invoices. You issue an invoice to your client, usually after completion of a job, that summarizes the work performed, payment amount, payment terms and due date (e.g., within 30 days of receipt). This allows a company to anticipate incoming credit and identify any late or non-paying customers.

[For more on business accounting, see How Management Accounting Streamlines Your Business Operations.]

Accounts receivable is the flip side of accounts payable, which is a liability or an amount you owe someone else. The money your client owes you would fall under their accounts payable.

Setting up your accounts receivable

According to the SBA, you can use a traditional spreadsheet or an accounting software, like QuickBooks or Expensify, to set up your account.

There are two standard models of accounts receivable:

  • Cash basis accounting, where you’ll record a transaction once a payment is received.
  • Accrual basis accounting, where you’ll record it as soon as an invoice is sent out, regardless of when the client actually pays you.

With a few exceptions for special types of income, the IRS generally allows businesses to choose between cash or accrual basis accounting, depending on which suits them best. However, you must stick with your chosen method. If you decide later that you want to switch, you’ll need to get IRS approval.

Your accounts receivable consists of money or credits owed to your company by its customers and clients.

Recording and tracking accounts receivable

To begin tracking your accounts receivable, there is a general order of steps to take.

  • Submit the invoice. You’ll have to first create and send an invoice to your client. You should do this as soon as possible after a job is completed so as not to delay payment and hurt your cash flow.
  • Track invoice status. Once sent, track the status of your invoice and be sure to follow up with the client if payment is not issued by the due date.
  • Record payment. Record the paid invoice in your books. Be sure to record in the proper manner depending on whether you’re using the cash basis accounting method versus the accrual basis accounting method.
  • Asses your methods. The recording process will help you identify any gaps or concerns in your invoicing. If you’re facing issues with cash flow due to late or non-payments, consider whether you’re allowing too much time for clients to pay their debts. You might even consider sending periodic invoice reminders or offering incentives for early payers.

To better understand how well you handle your accounts receivable, you might want to determine your accounts receivable turnover ratio. The higher the ratio, the better off you are. To calculate it, simply divide the net credit sales over a specified period by the average account receivables, according to The Street.

Your accounts receivable directly impacts your cash flow, and it’s crucial to keep up to date on your invoices. If necessary, don’t be afraid to make any adjustments to your payment terms if it will help your business.

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