Maximizing cash-flows with accounts receivable management

Better accounts receivable management means more working capital for growth. This blog covers A to Z of accounts receivable, discussing techniques to optimize financial efficiency by strategically managing accounts receivable. Discover strategic approaches to streamline processes, minimize risk, and uncover the potential for growth within your existing cash-flows.
May 31, 2024
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While evaluating business performance, metrics like revenue and profit typically take center stage. However, there is one metric that can make all else feel like vanity — cash-flows. It is the lifeline of your business, a key to meeting credit obligations, seizing growth opportunities, and weathering tough times — like a rock in a raging river.

Despite it, many businesses overlook the critical distinction between profits, revenues and the short-term liquidity provided by cash-flows. This oversight can result in serious repercussions, such as cash shortages, foregone growth opportunities, or even the devastating closure of a business. A staggering 80% of businesses fail due to cash-flow mismanagement.

Even the most successful companies can overlook the importance of cash-flows.

Michael Dell, the founder and CEO of Dell Technologies, once remarked, “We were always focused on our profit and loss statement. But cash-flow was not a regularly discussed topic. It was as if we were driving along, watching only the speedometer, when in fact we were running out of gas.”

Cash-flow is a dynamic process involving cash inflows and outflows. This article delves into a crucial component of this process — accounts receivable management. By effectively managing accounts receivable, you can ensure a consistent and timely cash inflow, thereby fortifying the financial health of your business.

This guide explores the intricacies of accounts receivable and offers specific strategies and insights to enhance cash inflow management.

What are accounts receivable?

Accounts receivable (AR) represents the outstanding invoices or the money owed to a company for goods or services. This asset category on the balance sheet signifies the credit sales due for payment within a specific period, usually under 12 months. 

Accounts receivable management is critical for cash-flow and liquidity. It covers tasks such as invoicing, due date tracking, and collections. Effective accounts receivable management ensures prompt payments, minimizes bad debt risk, and fosters financial stability for the business.

Examples of accounts receivable

Here are some examples to illustrate various scenarios where a company would have accounts receivable:

  1. Annual subscription fees: A SaaS company provides project management software to various corporate clients. After clients sign up for a yearly subscription, the company invoices them for the subscription fees. These outstanding invoices represent accounts receivable until the clients make the payments.
  2. Usage-based billing: A SaaS provider offers a data analytics platform with usage-based billing. Corporate clients are billed at the end of each month based on their data usage. The monthly invoices sent to the clients are considered accounts receivable until the payments are made.
  3. Performance-based billing: A SaaS company offers marketing automation software with performance-based billing, where clients are charged based on the outcomes of their campaigns. At the end of each campaign period, the company invoices the clients based on the results achieved. These invoices are part of the accounts receivable until the payment is made.

Note: When a customer subscribes but hasn't paid yet, the revenue is recognized in the income statement against the service being provided, contributing to the profit. However, the actual cash-flow remains unaffected until the payment is received, with the amount recorded as accounts receivable on the balance sheet. Once payment is made, it then impacts the cash-flow statement under operating activities. 

Extending credit terms through accounts receivable is crucial for businesses. It helps to build strong client relationships, bolsters competitiveness and encourages customers to make larger purchases. However, if it is not prudently managed, it can lead to irreversible financial disasters. 

The critical role of the account receivable management process 

Accounts receivable management allows businesses the luxury of leveraging the receivables for business growth while also protecting it from all financial risks. It helps ensure a steady stream of cash inflow while also mitigating potential financial risks. Let's see how.

1. Optimizes cash-flow:

Efficient accounts receivable management ensures that the company receives customer payments promptly, thereby improving cash-flow. This steady inflow of cash enables the business to meet its financial commitments without experiencing liquidity constraints. These commitments could be as simple as paying suppliers or as ambitious as launching a new product - cash-flow makes it possible.

2. Minimizes bad debt risk:

Effective accounts receivable management assesses customers' creditworthiness before extending credit. Identifying and addressing potential risks of non-payment or defaults helps businesses reduce bad debt losses and protect their bottom line by implementing robust credit control measures.

3. Strengthens working capital management: 

Accounts receivable management impacts working capital management, as the latter involves monitoring and optimizing the balance between accounts receivable, accounts payable, and inventory. Businesses usually free up working capital for investment and growth by reducing the days sales outstanding(DSO) and improving the efficiency of collections.

4. Supports business growth: 

Efficient accounts receivable management provides the financial stability needed to support business growth initiatives through timely and predictable cash-flows. Whether expanding operations, investing in new equipment, or launching new products or services, a healthy cash-flow position enables businesses to seize opportunities for expansion and innovation.

5. Enhances customer relationships: 

While accounts receivable management involves collecting payments from customers, it also aids in maintaining positive and constructive relationships with them. Clear communication, transparent billing practices, and responsive customer service contribute to customer satisfaction and loyalty, fostering long-term, mutually beneficial partnerships.

6. Facilitates financial decision-making: 

Accurate and current accounts receivable (AR) data provides valuable insights into a business's financial performance and overall health. By examining accounts receivable metrics such as DSO (Days Sales Outstanding), aging reports, and collection effectiveness, companies can make well-informed decisions about pricing strategies, credit policies, and resource allocation.

7. Makes regulatory compliance a piece of cake: 

Regulatory compliance becomes a part of everyday processes because accounts receivable management involves adherence to various regulatory requirements and accounting standards, such as revenue recognition rules and tax regulations. There are no bumps on the road.

Compliance with these standards ensures financial transparency, integrity, and accountability, safeguarding the company's reputation and mitigating legal and regulatory risks.

Timely and accurate management of accounts receivable can be the difference between a thriving business and one that struggles to stay afloat. 

In the next section, we will see what the accounts receivable management process looks like.

The accounts receivable management process

The accounts receivable management process is an 8-step cycle that helps businesses track and manage their accounts receivable and ensure that sales actually translate to actual revenue on time.

Here's a detailed view of the accounts receivable management process:
(AR management is not a linear process. A lot of these steps may happen simultaneously. We have used an order to bring out what the setup process looks like ideally.) 

Step 1: Invoicing and billing 

The Accounts receivable process begins with issuing accurate and timely invoices for goods delivered or services rendered. Invoices should include clear payment terms, due dates, and detailed information about the products or services provided. 

Step 2: Credit policies and terms 

The next step is establishing and enforcing credit policies for managing accounts receivable effectively. This involves determining credit limits for customers, setting payment terms (example — net 30 days), and assessing creditworthiness through credit checks and analysis. 

Step 3: Monitoring and tracking 

Accounts receivable professionals continuously monitor and track outstanding invoices to ensure timely payment. However, manually managing this task is highly challenging. To handle this efficiently, finance teams use smart accounting software to track payment status, aging reports, and customer balances.
Learn more about automating accounts receivable management with Zenskar here.

Step 4: Collections and follow up 

When invoices become past due, accounts receivable teams initiate collection efforts. This includes sending reminders, making phone calls, and sending collection letters to follow up on overdue payments. Persistent but professional communication is critical to encouraging prompt payment while maintaining positive customer relationships. This part of the process can be time-consuming, error-prone, and often perplexing when done manually. However, automating such routines can be game-changing for finance teams. 

Step 5: Dispute resolution 

Another aspect of accounts receivable management is resolving disputes or discrepancies related to invoices or payments. This may require collaboration with sales or customer service teams to address customer concerns and reach satisfactory resolutions. Having a single source of truth regarding data is key to this collaboration. 

Step 6: Cash application 

Once payments are received, the finance team applies the cash receipts to the corresponding invoices in the accounting system. Accurate and timely cash application ensures that customer accounts are updated correctly and reflect the business's current financial position. 

Step 7: Reporting and Analysis

Regular reporting and analysis of accounts receivable metrics are essential for evaluating performance and identifying areas for improvement. Key metrics include days sales outstanding (DSO), aging of receivable, collection effectiveness index(CEI), and bad debt ratios. 

Step 8: Process improvement: 

Accounts receivable management is an iterative process. Continuous improvement is essential for optimizing efficiency and effectiveness. Analyzing past performance, identifying bottlenecks, and implementing best practices and automation tools can help streamline processes and enhance overall performance.

Successful accounts receivable management requires strategic planning, proactive communication, and diligent execution. It also demands a solid commitment to exceed routine expectations and aim for the exemplary.

Common challenges faced in managing accounts receivable 

From struggling with late payments to grappling with complex disputes, managing accounts receivable presents several challenges for businesses.
Here are some common challenges faced in accounts receivable management:

1. Delayed payments: 

Dealing with customers who consistently pay invoices late or past the agreed-upon terms is one of the most prevalent challenges. Delayed payments can disrupt cash-flows and strain liquidity, impacting the company's ability to meet its financial obligations and invest in growth opportunities. 

2. Disputes and deductions:

 Resolving disputes and deductions related to invoices can drain time and resources. Customers may raise concerns about the quality of goods or services delivered, pricing discrepancies, or billing errors, necessitating thorough investigation and negotiation for resolution. 

3. Credit risk and bad debts:

Assessing and managing credit risk is essential to minimize the risk of bad debts. Extending credit to customers without adequately evaluating their creditworthiness can result in non-payment or default, leading to financial losses or write-offs. 

4.  Inefficient collection processes:

Inefficient collection processes can lead to ineffective follow-up on overdue invoices and missed opportunities to recover outstanding payments. Without clear escalation procedures and consistent communication, accounts receivable teams struggle to prioritize collection efforts and reduce delinquencies. 

5.Manual and paper-based processes:

Reliance on manual and paper-based processes for invoicing, billing, and collections hinders efficiency and increases the likelihood of errors. Manual data entry and reconciliation tasks are prone to mistakes and delays, impacting the accuracy and timeliness of financial reporting. 

6. Lack of automation and integration: 

Limited automation and integration between accounting systems, customer relationship management (CRM) software, and payment platforms can impede visibility and coordination across departments. Siloed systems and fragmented data hinder decision-making and the efforts to streamline accounts receivable processes. Implementing an integrated software solution that automates invoicing, billing, and collections can significantly improve efficiency and reduce errors in accounts receivable management. 

7. Regulatory compliance: 

Conforming to regulatory requirements, such as tax regulations and accounting standards, poses compliance challenges for accounts receivable management. Non-compliance with these regulations opens the door to penalties, fines, and damage to the business's reputation.

8. Customer relationships: 

Balancing the need to collect payments while maintaining positive customer relationships can be challenging. Overly aggressive collection tactics may strain customer relationships and damage goodwill, while leniency may result in increased delinquencies and late payments. 

To tackle these challenges, businesses must adopt a strategic approach to account receivable management, utilizing best practices and effective communication tactics. But perhaps the most crucial aspect is deploying the right technology, a solution that streamlines routines, provides insightful reports and analytics, and sets your business up on the road to sustained success.

Streamlining the accounts receivable process end-to-end

Streamlining the accounts receivable process is crucial for enhancing efficiency, accelerating cash-flows, and reducing operational costs. 

We will take a look at nine strategies to streamline the accounts receivable process effectively:

Implement software automation: 

Investing in accounting software to automate redundant accounts receivable management tasks such as invoice generation, payment follow-ups, and cash application is pivotal. Automation reduces manual effort, minimizes error, and speeds up processing times. It can transform the whole function.

Companies that have automated over 50% of their accounts receivable processes have reported a 32% reduction in DSO, equivalent to 19 days. 

1. Standardize processes: 

Develop standardized procedures and workflows for accounts receivable tasks, from invoicing and billing to collections and reconciliation. Create clear documentation for these processes to ensure consistency and efficiency across the organization. 

2. Use electronic invoicing:

 Transition from paper-based invoicing to electronic invoicing to expedite delivery, reduce administrative overhead, and encourage prompt payment from customers. E-invoicing also enables real-time tracking and monitoring of invoice status. 

3. Offer multiple payment options: 

Provide customers with convenient and flexible payment options — online, credit card, and automated recurring payments. Offering diverse payment methods increases the likelihood of timely payments and reduces processing delays. 

4. Establish clear credit policies: 

Define clear credit policies and terms for customers, including credit limits, payment terms, and penalties for late payments. Communicate these policies upfront and enforce them consistently to encourage timely payment behavior. 

5. Improve communication: 

Maintain open and proactive communication with customers throughout the invoicing and collection process. Nudge them with regular payment reminders, promptly follow up on overdue invoices, and address any billing inquiries or disputes. 

6. Streamline collection efforts: 

Prioritize collection efforts based on factors such as payment history, account status, and customer relationship. Segment customers based on their creditworthiness and payment behavior to tailor collection strategies effectively. 

7. Centralized data management: 

Consolidate accounts receivable data and centralize data management to ensure accessibility, accuracy, and consistency. A centralized repository for customer information, invoices, and payment records streamlines processes and facilitates reporting and analysis. 

8. Monitor key metrics: 

Regularly monitor key accounts receivable metrics such as days sales outstanding (DSO),
aging reports, collection effectiveness, and cash-flow projections. Use these metrics to identify bottlenecks, measure performance, and implement process improvements.

Often, strategies and best practices are born from implementing cutting-edge software that centralizes processes, enhances data accessibility and visibility, and proactively flags any areas needing attention through insightful reporting. It is like a friend having your back, but in this case, it is on autopilot.

Software like Zenskar not only expedites the setup process but also optimizes the entire workflow, efficiently helping you manage the accounts receivable cycle without a hitch. 

Accounts receivable with Zenskar

Zenskar transforms how you manage accounts receivable by automating invoicing and payment tracking, ensuring timely collections, and drastically reducing manual errors. With Zenskar, you can fast-track collections, improve cash-flows, and enhance financial efficiency, giving your business a significant competitive edge.

1. Hand over repetitive routines

Automate everyday routines such as invoicing and follow-ups to minimize errors and eliminate redundant work. You can implement automated reminders for overdue invoices to maintain timely customer communication. So you never miss a follow-up. Never.

For businesses using subscription models, Zenskar offers automated billing cycles to ensure consistent and accurate invoicing.

Furthermore, Zenskar integrates with payment gateways to automate payment collection, reconciliation, and recording, streamlining the entire payment process.

2. Be in the know of all things accounts receivable.

Zenskar empowers you to stay on top of all things accounts receivable through a powerful dashboard. The centralized, real-time dashboard provides a comprehensive view of accounts receivable status, including key metrics such as total outstanding receivable, overdue amounts, and payment statuses. It also enables insights into customer payment behaviors, helping you identify trends like late payments or frequent disputes to plan for interventions.

Additionally, you can customize the accounts receivable dashboard to show relevant information, creating the best context for decision-making for your business.

3. Let the metrics map out your next steps.

Track essential KPIs such as DSO, collection efficiency, and average payment times to understand your accounts receivable performance. Analyze payment trends over time to identify patterns and predict future cash-flows. Zenskar helps translate raw data into actionable insights, allowing you to adjust credit terms or implement stricter follow-up procedures based on customer payment behavior.

You can also leverage accounts receivable metrics to inform broader financial strategies and generate custom reports tailored to your specific needs for informed decision-making.

"Manual follow-ups were often missed, leading to delayed payments. Thanks to Zenskar, we no longer have to do this manually. After automating our receivables with Zenskar, our DSO was reduced by five days." - Cory Linton, CEO, Edify

Looking to speed up payments and increase cash-flows? Schedule a demo with Zenskar today. Our team of champs will answer all your questions and show you how Zenskar can transform accounts receivable for your business in 20 minutes.

Frequently asked questions (FAQs) 

1. How do you manage accounts receivable effectively?

Manage accounts receivable effectively by establishing clear credit policies, invoicing promptly, and offering diverse payment options. Monitor receivables closely, prioritize collections efforts, and maintain open communication with customers. Automate invoicing and collections processes, streamline workflows, and provide staff training. Analyze accounts receivable metrics regularly to identify trends and areas for improvement. Optimize cash-flows by reducing days sales outstanding (DSO) and minimizing bad debt risk while fostering strong customer relationships.

2. How are accounts payable different from accounts receivable?

When a company has accounts receivable, it means that its customers owe them money for goods or services provided. On the other hand, when a company has accounts payable, it means that they owe money to their suppliers for goods or services received. Simply put, receivables are incoming payments, while payables are outgoing payments.

3. How does accounts receivable influence cash-flows?

Accounts receivable have a significant impact on cash-flows as they represent money owed to the company. Efficient and timely collection of receivables improves cash-flows, providing essential liquidity for daily operations, investments, and debt repayments.

On the other hand, delays or inefficiencies in collecting receivables can strain cash-flows and jeopardize the company's financial stability.

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