Accounts Receivable Cycle : Step By Step Guide
To many business leaders, the accounts receivable cycle is thought of as solely cash collections, but it’s actually more complex than that. Playing a vital role in the accounting cycle and overall business functions, the accounts receivable team is responsible for reviewing purchase orders, checking each customer’s credit, granting appropriate credit terms, sending invoices, collecting payments, and managing key financial metrics such as AR aging and bad debt. This stage of the accounting cycle is also known as the AR cycle or accounts receivable stage
No matter what product or service your business is selling, the full cycle accounts receivable is critical to your success. Without proper cash collection, you’ll have cash flow and liquidity challenges; without thoughtful customer contracts, customer relationships could suffer; and without keeping a close eye on AR metrics, your leadership team will be unable to make the right business decisions. The accounts receivable process is to thank for every cent of incoming cash flow to your business.
In this article, we’ll show you the full cycle AR process, highlight the benefits of a well-managed AR cycle, and help you understand the ways in which automation/technology can streamline AR-related tasks. You’ll get all your burning questions answered.
What is the Accounts Receivable Process or AR Cycle?
AR processing is more than sending payment reminders to customers and chasing down late payments. If that’s where your organization’s AR strategy starts, you’re going to hemorrhage cash and spend more time cleaning up messes than doing business.
The accounts receivable cycle or AR cycle commences upon product or service delivery without immediate payment and concludes when the invoice is fully settled and payment is received.
The full cycle AR actually starts with properly reviewing every purchase order your business receives from a customer looking to make a purchase. It’s easiest to look at the cycle visually, so let’s start there.
As the flow chart illustrates, there’s a lot more to AR management than meets the eye. Yes, you need your AR team to feel comfortable having difficult conversations with customers who have unpaid invoices, but you also need them to be proactive, manage risk, and conduct detailed AR reporting.
To better showcase the importance of each of the above steps, let’s go through them 1 by 1.
Steps in the Accounts Receivable Process: The Complete AR Cycle Workflow
If the accounts receivable account, which is an asset, doesn’t materialize into cash, you’re leaving money on the table and putting your business at risk. When looking at the full cycle, accounts receivable optimization depends on each and every step. One is not more important than another, but rather, each step in the AR cycle impacts your organization’s ability to collect cash and boost profit margins.
Step 1: Customer Places an Order
Whether you work in the B2B space or the B2C space, customers have to place orders to initiate the accounts receivable cycle. In the B2B space, when a purchase order is received, one of the first teams that will see it is the AR team. They must conduct proper due diligence to ensure that the purchase order is legitimate, contains the correct information, and isn’t fraudulent. At this stage, the sales team may be involved to give AR a heads-up about an incoming order.
Step 2: Credit Review & Approval
With a legitimate PO in hand, accounts receivables experts must further insulate your business from risk by assessing the creditworthiness of each customer. For new customers, a thorough credit application process should never be skipped. With existing customers, look at their payment history with your organization. Do they pay on time? Have they ever missed a payment? Keeping a detailed customer record is key to lowering bad debt and mitigating financial risk.
Step 3: AR Sends an Invoice
Once a customer’s creditworthiness is determined, and your AR team feels comfortable continuing with the fulfillment process, an invoice is sent to the customer. The invoice should include the payment terms, what product is being purchased, and the contact information for both companies. In the same way AP automation helps the AP team automatically process and pay incoming invoices, AR automation supports the sender side of that transaction.
Step 4: Send Payment Reminders & Collect Funds
After an invoice is sent, the clock starts. Customers only have the specified payment window to submit payments. If their payment terms are N30, meaning they are contractually obligated to pay the invoice within 30 days of its receipt, your AR team should be sending payment reminders periodically until payment is received. To make things even easier, automate payment reminders and other repetitive tasks using accounting automation software.
Step 5: Update Bad Debt/Write Off Uncollected Funds
Although not ideal, a reality in doing business is that there is always going to be a customer or two that don’t pay. It can be a major financial hit when this happens, which is why thoroughly conducting each step in the accounts receivable cycle is imperative. If all attempts to collect payment are ignored by the customer, the debt will be written off as a bad debt. The timeline for writing off a bad debt will depend on your industry, the customer’s payment terms, and any special circumstances involved with that specific PO.
Step 6: Receive & Process Incoming Payments
On the plus side, most customers will pay their bills. When funds are received, the AR team needs to close out the invoice and update the account receivables tracking mechanisms you have in your organization. Make it as easy as possible for customers to pay by offering automatic payments, ACH, wire transfers, or other ways to pay.
Step 7: Deal with Disputes
This won’t be part of every AR process, but if a customer is disputing an invoice for any reason, this is the time to handle that situation. Perhaps they weren’t satisfied with the product they received or claim to have never received it. AR will need to do its best to resolve disputes and collect funds. Sometimes, customers will pay a portion of the invoice – a short payment – and it’s up to AR to find out why that happened and chart a path to collecting the payment in full.
Step 8: Manage AR Reporting
There are many metrics that are critical when it comes to the full cycle accounts receivable process. The AR Turnover Ratio, Days Sales Outstanding (DSO), and the Collections Effectiveness Index are a few common metrics managed by the AR team. During the month-end close process, which is the last step of the overall accounting cycle, the AR team will submit necessary journal entries and ensure the AR accounts on the general ledger are properly updated.
Benefits of Automating the Accounts Receivables Cycle
In the same way that manufacturing software can be used to automate much of the manufacturing process, automation software can (and should!) be deployed throughout the AR cycle. AR processing is tedious, complex, and requires a lot of detailed tracking to “get it right.” It can be hard for even the best AR teams to keep up with payment reminders, credit checks, month-end reporting, and the many other demands that come with their roles.
With the right automation tools and proper implementation, your AR team will experience enhanced productivity, better reporting, and many other benefits.
Reduced Processing Time
AR processing is nothing if not time-consuming. The more purchase orders you have coming in – which is great for business – the more strain your AR team experiences. With automation, e-invoices can be created and sent to customers automatically, payments can be received without human intervention, and even credit checks can be initiated by a computer. With all the time savings your AR team will experience, they’ll be able to focus their days on more value-add activities.
Business Scalability
If you want to be able to grow your business, AR needs to be able to keep up with that growth. The same team of, let’s say 3 people, can’t go from managing all AR processing for 30 customers to managing all AR processing for 3,000 customers. To achieve that level of scale, automation tools are essential.
Automated Reminders and Collections
Chasing down payments can be a full-time job in and of itself. With automated reminders, automated payment processing, and automated system updates, AR teams can focus on up-front due diligence, customer relationships, and functional KPIs. Automated reminders alone can improve your AR Turnover Ratio, boost cash flow, and ultimately, impact the bottom line.
Fewer Data Errors
When it’s time for the month-end close, if any data throughout the month was recorded incorrectly, it can take a long time to unravel the thread and understand where the mistake happened. But, with automation, computers copy data seamlessly, very rarely making data entry mistakes like their human counterparts.
Cost Savings
Beyond improving the collections effectiveness index, there are very real cost savings waiting to be realized by automating the accounts receivable cycle. Fewer people can process more transactions, your organization’s cash flow levels will be healthier, and you’ll write off less bad debt than ever before.
Improved Insights & Reporting Capabilities
Financial reporting and data-driven insights help drive business decisions. In the past, AR teams didn’t have the bandwidth for top-notch reporting because all of their time was spent making collections calls and conducting credit checks. Now, with automation, that time has freed up, but it doesn’t stop there. The best software solutions come with integrated dashboard capabilities and reporting features that provide real-time updates on the most important metrics that your leadership team relies on.
Stop Leaving Money on the Table
It’s a simple fact that the more effective an organization’s AR process is, the better that organization will perform. You can’t continue doing business without enough cash flow to sustain your operations, and you won’t have any cash flow without the accounts receivable process.
The accounts receivable process has been and will always be a key business function, but with today’s robotic process automation capabilities, it can have an even bigger impact on your business. Investing in AR automation will cost money, but not investing in AR automation will end up costing more in the long run. Don’t leave money on the table.
