In: Accounting
What is the Account Receivable cycle in details? please provide the link of the book or the research paper
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Accounts Receivable (AR) refers to the outstanding invoices a company has, or the money it is owed from its clients. In your personal life, an example of Accounts Receivable would be buying a ticket to a concert or sporting event for a friend with the understanding that they will pay you back later. It’s essentially an “IOU”. In business, AR represents a line of credit extended by a company, due within a relatively short timeframe, which could range from a few days to a year.
What is an Accounts Receivable?
If a company has Receivables, then they’ve made a sale, but have not yet collected the money from the purchaser. Most companies operate by allowing a portion of their sales to be on credit, offering their clients the ability to pay after receiving the service.
For example, utility companies typically bill their customers after they have received electricity. While the utility or energy company waits for its customers to pay their bills, the unpaid invoices are considered Accounts Receivable.
Most businesses operate by enabling their clients to buy goods in credit. The cost of sales on credit is what is referred to as Accounts Receivable. Generally, Accounts Receivable (AR), are the amount of money owed to the company by buyers for goods and services rendered. The Receivables should not be confused with Accounts Payable (AP).
While AP is the debt a company owes to its suppliers or vendors, accounts receivable is the debt of the buyers to the company. Accounts Receivables are important assets to a firm, while Accounts Payable are liabilities that must be paid in the future by the company. Basically, firms choose to offer receivables to encourage customers to choose their products over the competitor’s products.
It is advisable for a company to setup an AR process to determine the customers that have already paid and identify any payments that are overdue. The process is a simple turn of events that make the Receivables traceable and manageable.
Four Main Steps for a Typical AR Process:
However, using economies of scale, the process may differ for large and small firms. Large firms have a larger cash inflow, so they typically invest in highly skilled credit management teams and IT systems to help improve and manage the process efficiently.
Step 1: Establishing Credit Practices
The first step is for the company to develop a credit application process.
The company will then decide, based on the credit-worthiness of the applicant, as to whether they will offer goods on credit. The company might choose to offer the credit to individual customers or other businesses.
Also, the company will establish terms and conditions for credit sales. The document outlines the client’s obligations and requirements. The firm must ensure that it complies with Federal laws on credit, such as full disclosure of the credit practices. For example, the company has to clearly communicate the interest rates for the credit.
The terms and conditions differ for large and small firms.
Large companies may opt to give a customer longer periods of time.
On the flip side, small firms cannot afford to offer goods on credit for longer periods due to their less cash flow and low capital. How soon the money is collected on this debt from the client will be a contributing factor in ascertaining the company’s capital needed to run the business and the cash flow.
Step 2: Invoicing Customers
An invoice is a document provided to the buyer detailing the products and services that have been rendered, the costs of those products and services, as well as the date payment is expected.
Each invoice has to have a unique invoice number for easy retrieval.
The customer is then given the chance to choose whether they want to receive electronic or physical invoices. Large firms prefer to send both the electronic and paper invoices.
Unlike paper invoices, electronic invoices are less expensive and convenient. As such, small firms mostly opt to use the mails to deliver the invoices.
The longer a company takes to send an invoice, the longer it takes for the customer to make payments. The invoice must be sent promptly.
Step 3: Tracking Accounts Receivable
This step is performed by an Accounts Receivables (AR) Officer. The Officer keys out a payment deposited into the bank account of the supplier, feeds it into the AR system, and then allocates it to an invoice.
The officer also reconciles the AR ledger to be certain that all the payments are accounted for and properly posted, and then issues monthly statements to clients. The statement provides details for the customers about the amounts owed as per previously sent invoices.
The tracking process differs in large and small companies.
Smaller companies may not have an advanced system in place to track payments, and may use manual AR tracking by using tools, such as Excel. In a manual process, companies use spreadsheets to record when they send the invoices, and when they receive payments. Small companies also may not have enough staff to appoint an AR Officer, in which the company may hire a professional accountant to fulfill this function.
Larger companies typically invest in a team of AR Officers to conduct the tracking process, and they use some form of an accounts tracking software system to help ensure accuracy. The system helps the AR Officer to be more effective, because it automatically alerts the AR Officer to which debt is outstanding.
Step 4: Accounting for Accounts Receivable
The Collections Officer establishes the due date for payments. After identification of unpaid debts, the account department makes journal entries to record the sales. The process involves both accounting for bad debt, or the unpaid debts, as well as identifying early payment discounts.