What is accounts receivable: a complete guide

“Accounts Receivable” or “AR” describes the processes governing the collection of money owed to your business by its customers. The more you know about AR and the systems that underpin it, and the more efficient your AR systems are, the more quickly and easily your business can collect cash.

This guide will explain all aspects of AR as a function. And how accounts receivable automation software can improve accuracy and efficiency across your financial operations to improve your working capital, strategic decision-making, short- and long-term investment planning and growth trajectory. 

What is accounts receivable? 

Your business’s “accounts receivable” are the funds it’s legally entitled to for goods delivered or services rendered to your customers. In other words, they’re the money owed to you for sales made on a credit basis.

Your business’s accounts receivable team or department are responsible for ensuring that the money your customers owe you is tracked, received, and applied towards your pending balances.

Until a credit sale has made its way through your accounts receivable processes, your business won’t be able to realise the revenue from that sale, and therefore won’t be able to put it to good use generating further sales, investing in the business, or performing operational tasks.

The key metrics governing the smooth running of your accounts receivable are:

• Days’ Sales Outstanding (DSO): a measure of the overall size of your accounts receivable based on the number of sales made in an average day. For example, if your typical daily sales total is €15,000, and you have €120,000 in unpaid invoices, your business can be said to have 8 days’ sales outstanding.
• Working capital: a measure of your business’s operating liquidity represented by your current assets net your current liabilities. The more successfully your AR teams can secure receipt of outstanding sales, the greater your working capital is likely to be.
• Collections Effectiveness Index (CEI): compares how much was owed to a business and how much it managed to collect over a given period. The closer to 100%, the more robust and effective your AR processes. Although superficially similar to DSO, the CEI measures the business’s effectiveness in collecting invoices rather than the time it takes to collect an invoice on average.
• Past-Due AR: the amount of outstanding invoices that are past the due-date specified in your payment terms. The greater your past-due debt, the more likely it is that you aren’t collecting payments efficiently and your processes need to be improved.
• Bad debt write-offs: the larger your outstanding “bad debt” (uncollectible funds), the more likely your business is to be prone to credit risk and to have poor financial health. Keeping bad debt low is therefore essential – particularly as every dollar of debt you write off requires many more successful collections to get you back to where you should be.
• Cash Asset Ratio:  a measure of your current net assets minus current net liabilities. Demonstrates your ability to pay short-term obligations, and gives a sense of how efficient your operating cycle is and your ability to stay liquid.
• Cost of credit: if you’re running your business on a credit sales model, then you’ll likely need to use credit of your own to finance some of your operations. “Cost of credit” is the money you pay to your banks to provide this credit. A smoother AR process means lower cost of credit as you’ll rely on fewer loans to secure liquidity.
• Cost of finance: also known as “cost of finance operations”, this is a measure of the overall expenditure the business incurs to handle financial tasks. The lower it is, the more streamlined and efficient your AR teams are likely to be.
• Payment error rate: a measure of the proportion of your payments which aren’t processed “straight through” from invoice to application. The more erroneous or interrupted payments you’re having to handle, the more bogged down your AR teams will be, and the less able they’ll be to help the business access the cash it needs to perform. 

What is the accounts receivable process? - Step by step

Generally, the AR workflow consists of the following:

1. Customer onboarding and contract agreement

The AR process begins by creating a contract between your business and your customer, and uploading their company details into your relevant systems to track commitments, obligations, terms, and any charges and payments received.

What exactly this part of the process looks like will differ significantly depending on your practices and the software you use, and may be managed on a variety of different formats.

2. Customer credit approval

Before you can start delivering goods or sending invoices, you’ll need to assess your customers’ creditworthiness to determine whether or not they can even afford to buy from you. This is particularly important if you’re working with extended payment terms or significantly large sums of money.

Based on your credit policies and risk appetite, you may consider approving or denying credit, or suggesting more restrictive payment terms to manage the potential downside of working with a given customer.

3. Invoice generation

Once the terms of a sale have been agreed (and, if applicable, your customer has created a purchase order), your Accounts Receivable team will generate an invoice.

The invoice is a legal document finalizing your business’s agreement with your customer that they will pay a specific amount for a specific product or service. It acts as the definitive record of your customer’s purchase.

This can either be done manually (generally in the form of a word document) or through a variety of different specialized software solutions or accounting systems.

An invoice will generally record:

• An itemized list of the goods or services sold by your business to the customer, according to the terms of the contract governing the sale.
• The costs charged for each item.
• A note of preferred payment methods.
• A reminder or notice of payment terms – including contractual or statutory payment timeframes.

4. Invoice posting

Once an invoice is sent to the client, it is entered into the business’s accounting system, and is said to be “posted”. At this point, your AR team can register it as a “debt owed”, and as a credit in your sales system.

A posted invoice is taken to be final, and generally should not be changed. As a result, any errors discovered after posting usually require a much higher degree of effort and time to rectify.

5. Collections management

Based on payment terms, or following successful delivery, your customer will hopefully pay the balance of the invoice according to the terms stipulated. If they do not, then it’s important to have a structured collections process to help your team follow up on overdue invoices. This can include gentle reminders once an invoice is a week overdue, to more formal measures like the involvement of legal counsel or collections agencies as outstanding debt becomes more and more delinquent.

One of your AR team’s most important tasks is ensuring that every customer settles their balances within the timeframes specified in your agreements and invoices. If this doesn’t happen, invoices will be marked as late, and run an increasing risk of becoming “bad debt”. We’ll talk more about what might happen in these instances below.

6. Payment receipt and processing

Payments can come in many forms, from checks to wire transfers, debit, credit, or electronic transfers. Efficiently processing different payment formats is essential not only for applying cash in the business, but also maintaining accurate financial records.

For electronic payments, you’ll need to maintain a payment processor and gateway, at least one merchant account, and a platform to support self-service payments. Some providers wrap this into a single offering.

If, like most B2B businesses, you still accept a large number of paper checks, you’ll most likely need at least one bank lockbox service, in which your bank will receive and process checks for you. (Although managing your lockboxes will still require a sizeable input from your AR team.)

7. Cash application

Once you receive payment, your team will post it against the relevant invoices. This isn’t always a simple process, however, and discrepancies between payments received and invoice details (and missing remittance advice) can often result in delays as your AR team chases up customers or other teams to reconcile information.

8. Dispute management 

Customers may take issue with invoices. In these cases, a disputes team will handle their objections with reference to existing agreements between your business and the customer, and attempt to come to a mutually satisfactory agreement so that revenue can be recognized as swiftly as possible.

9. Dunning

If payments are late, businesses can begin a “dunning” process, which involves sending escalating reminders or collection letters to encourage prompt payment. This can include notifying customers of potential late fees or other consequences.

10. Reporting and analytics

Regular AR reporting on metrics like DSO and collections effectiveness index (CEI) is key to effective financial planning and assessing your AR process. It’s typically undertaken through the month-end close process, when your teams will check they’ve properly recorded transactions and create a trial balance based on all general ledger accounts. 

What are the main functions of an accounts receivable department?

What is your accounts receivable department for? Put simply, it’s their job to ensure all payments due to your business are received on time and processed through to application as quickly as possible. 

No matter how small or large, the AR team plays a critical role in any organization. These include: 

• Generating invoices and statements of account: AR teams are responsible for creating and presenting invoices to customers as legal statements of goods or services rendered. They will then tally invoice amounts and add them to the balance sheet as either sales revenue, cash, or accounts receivable depending on whether payment is made on delivery or on a credit basis.
• Creating monthly financial statements: the AR team will lead the process of verifying receipts and reconciling bank accounts at the end of each month to prepare monthly statements, intended to provide a concise overview of your cashflow and current position.
• Reconciling accounts: at the end of your accounting period, an accountant in your AR team will reconcile your accounts to ensure that the balances in your general ledger are complete and correct.
• Managing your billing system: the billing system is the process your business uses to bill customers. It can include electronic invoice templates, recurring workflows, payment automation software, and tracking and monitoring mechanisms and solutions for expenses and bills.

What is the accounts receivable department’s main goal?

Your AR department’s main goal is maximizing your business’s payment recovery for the goods and services you sell. This is generally indicated by DSO as a measure of the number of days on average it takes from the posting of an invoice to the collection of the payment. The lower your DSO, the more effectively your AR department is accomplishing its main goal. Lowering DSO requires implementing strategies, processes, and technologies that streamline payment collection as much as possible.

Because of this main goal, your team will also need to consider the following:

• Streamlining the invoicing process: invoicing is one of the AR team’s most fundamental responsibilities, and they “own” the invoice from creation to final settlement. Creating a process that makes invoice creation and fulfilment simple, clear, and transparent not only supports cashflow management and financial strength, it also ensures transactions are smoother and fosters trust between the business and its customers.
• Applying cash quickly and accurately: ensuring that incoming cash contributes to working capital as quickly as possible is another AR essential. This requires processes for the efficient application of cash to maximize the resources available to the business and prevent payments being “lost in the system”.
• Guaranteeing compliance: your AR teams will also be on the front lines of regulatory and reporting requirements, as well as withholding relevant taxes and other deductions from your customer payments. Processes have to factor in regulatory duties to prevent fines, and to prevent errors that lead to overpayments or incorrect disclosures.
• Keeping dunning and collections management smooth: recovering outstanding debts efficiently is another key plank of optimizing working capital and keeping DSO low. It involves extensive collaboration with your sales department to gather customer information, communication with customers to address payment issues and send reminders, and working to agree payment schedules that are fair and understandable for all parties.
• Creating a better customer experience: the easier it is for customers to pay, the more likely they are to pay quickly, and the more satisfied they’re likely to be. This requires your AR team to implement processes and technologies that make payments as convenient and transparent as possible.
• Tracking and securing overdue payments and mitigating bad debt: safeguarding against bad debt is one of your AR team’s’ most important tasks, and contributes significantly to your business’s overall financial health. It entails taking steps and implementing measures to minimize credit risk, identify delinquent customers quickly, and take proactive steps to collect overdue invoices.
• Reducing DSO: low DSO is one of the most important predictors of overall financial health, and finding ways to reduce it will always be close to the top of your AR teams’ agenda.

Why is the AR process so error-prone?

Put simply, AR is a naturally error-prone process because it deals with information from a variety of different sources which may not all use a single standardized format.

Requests to generate invoices usually come to your AR team either from your sales department or other lines of business. If you aren’t using business-wide software systems or standardized document formats, these might take many different forms. If your teams are working in Excel sheets, errors might already have developed before the relevant information even reaches your AR team.

Combined with the multiplicity of tasks and AR team is expected to manage (across invoicing, posting, collections management, and so on), it’s very easy for manual errors to creep into individual transactions.

While this is understandable, manual errors can have a huge cost to your business and its financial health. In effect, each error will likely double the time taken to fully process an invoice through to collection. It will also increase the effort your customers need to put into paying you, potentially damaging your relationship and reducing the likelihood that you’ll win repeat business.

What are accounts recievable´s main challenges? 

Your accounts receivable team is likely battling with at least some of the following challenges: 

• Error-prone processes: as mentioned above, AR processes can be extremely error-prone when your teams conduct them manually. This has a measurable impact on your teams’ efficiency – and it’s difficult to fix without the right automation solutions. 
• Exception handling: because many AR teams don’t have a strictly routinized process, handling exceptions is often the norm rather than the exception. This creates inefficiencies and opportunities for error in every part of your teams’ workflow.  
• Delayed cash allocation: the more bogged down your teams are in process management, the longer it takes for working capital to become available, due to unapplied or misapplied cash, meaning less flexibility and strategic decision making power across the whole business. 
• No visibility into Key KPIs: without the capacity for real-time reporting and analytics, your teams will never have a fully up-to-date picture of metrics like working capital and DSO. Outdated data can’t be used to fix current problems and make agile decisions. 
• Process fragmentation: if your cash application process can’t “see” data from the invoicing stage, or the credit checking stage, handovers will be longer, require more manual checking, and present opportunities for error. 
• Burnout: keeping on top of both the loose ends inherent to a manual AR process and the high volume of manual and repetitive tasks required takes its toll on your teams, and leads to reduced productivity, motivation and satisfaction – and ultimately to higher staff turnover. 

In addition, these issues in your AR team have an impact on the wider finance team and your IT department and business process owners. For business process owners, they lead to poor staff efficiency and headcount issues, along with higher operational costs associated with complex and easily duplicated processes. These in turn mean a worse customer experience, encouraging more defections. For IT, it means greater risks to data security and privacy, a higher cost overhead associated with data growth and the maintenance of multiple legacy systems, long enquiry times due to lack of data visibility, and a higher ticket volume from the business. 

How technology can help streamline AR, reduce errors, and overcome challenges

Accounts receivable automation removes much of the strain inherent in handling common AR tasks – and many of the opportunities for errors caused by handling these processes manually – through 4 main principles:

1. Easing the strain: a solution that keeps track of your invoices, sends reminders automatically, prioritizes collection steps, and provides access to relevant documentation contributes to a simpler and more effective solution for ensuring that payments are made on time and applied quickly and effectively.

2. Consolidating information: bringing data from different systems and inputs together in a single platform eliminates the effort wasted in tracking down customer details, reconciling different versions of contracts, and assessing who has said what to whom to establish the correct path for dispute resolution. It also provides an easy way to keep track of the payment status of every invoice posted, their priority for collections management, and any necessary immediate actions.

3. Unifying and simplifying processes: a digital automated solution for AR helps to eliminate inconsistencies by creating rules-based processes for every stage of your main AR workflows. Making collecting payments simpler for your teams and without any surprises.

4. Enhancing communication and visibility: the right solution not only simplifies the experience of handling AR processes for your teams, but also provides a better experience for your customers and employees. A single portal for the processing of payment requests for all parties reduces disputes, improves the likelihood of timely payments, and supports the strengthening of your customer relationships and repeat purchase prospects. It can also help reduce errors in your AR processes by improving conditions for your people, reducing chances for burnout, and reducing opportunities for errors.

What is accounts receivable automation – and why is it essential? 

“Automation” is simply any digitized process which eliminates the strain of manual work like, for example, chasing down remittance advice or checking on and reconciling data in different systems. Eliminating manual labor reduces your overall cost burden by ensuring processes are uniform and standardized, taking the pressure off your people, and ultimately ensuring faster cashflow. 

Here's what it can do for you: 

For your finance teams, it can: 

• Improve process and people efficiency by standardizing processes across the AR department.
• Reduce manual activities and allow them to focus on more complex cases and exception handling.
• Reduce unallocated cash and update customer accounts automatically overnight to deliver new actions in the morning.
• Enable real-time monitoring of important KPIs for full transparency of your processes and cash flow.
• Unify the processing of all incoming payment formats to further reduce manual input.
• Increase visibility to key KPIs like working capital, DSO, and cashflow.
• Help create better collection strategies.
• Understand customer payment behaviors

For your business process owners, it can: 

• Improve your bottom line by reducing operational costs.
• Streamline processes across regions & teams and create a unified global AR ecosystem.
• Simplify processes and boost productivity across the entire business.
• Scale processes faster when volume increases due to organic growth or M&A activities.
• Improve productivity across regions and help maintain a level playing field.
• Allow better staff utilization by reducing time spent handling routine tasks and allowing teams to focus on more strategic work and exception handling.

For your IT teams, it can: 

• Minimize security risks and improve security posture in line with standard regulations and policies.
• Standardize IT systems to enable cost reductions and reductions in maintenance overhead.
• Effectively transition to newer technologies to enable innovation across the business.
• Help leverage AL and ML technology to support business needs.
• Make upgrades simpler and migrations easy.
• Transition the business to solutions that can be maintained and owned in-house, reducing ticket volumes.
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What are the benefits of automation in AR?

Invoicing is fast and simple: your teams can quickly generate and post invoices as soon as orders are confirmed – making for clearer customer communication and, ultimately, faster payments.

Collections manage themselves: a smart collection solution lets you automate the entire process – setting rules that determine which accounts to prioritize and automate reminder emails and other correspondence, along with flags to escalate specific cases to human exception handlers. This makes the whole process smoother and simpler for your team, and allows them to focus more on managing working capital than chasing after missing capital.

Payments made quicker – and processed as soon as they’re made: a fully functional digital payments portal doesn’t just make it simple for your customers to pay. It makes it possible for you to instantly capture payments and update your records in real-time by assigning incoming payments to invoices automatically – even when your remittance information isn’t available yet. As a plus, simpler payment options mean customers are more likely to pay on time, and less likely to become delinquent.

Processes are simpler, and scale effortlessly: with standardized automated processes across your entire AR ecosystem, your business’s growth won’t outpace your ability to collect and apply cash. Everyone across your order-to-cash cycle is on the same page – including those outside the AR team. This means less effort spent chasing information across teams, and better insight into current and future cashflow.

Record keeping, reporting, and analytics become instant: automation ensures all transactions and actions are recorded without human intervention, making the formerly onerous task of matching payments to invoices simple and allowing for real-time reporting and analytics. This in turn allows for predictive forecasting of customer payment habits, cash flow, and the ability to predict bad debt in advance to make better decisions about which orders to pursue.

Customers are happier and relationships are deeper: self-service options and clear and simple processes allow customers to easily raise queries, see exactly what’s expected of them, and easily make the payments they need to pay. Reducing disputes and relationship breakdowns and ensuring all parties know the exact status of every invoice and order at all times.

Your business saves on costs and captures value: a huge reduction in manual activity in all your AR processes means significant cost savings, and gives you the power to reallocate your staff to more strategic activities like the management and allocation of your working capital.

Data is always available: automation eliminates the need to rely on multiple subsystems, a mess of spreadsheets, and conflicting data from different sources. With real-time visibility into all your AR data, including the status of every open and closed invoice, everyone can work with the most up-to-date information. Making for smoother interactions across your business, and with customers.

What is accounts receivable automation capable of? Some key statistics

Serrala has helped over 2,000 businesses around the world to automate their invoice-to-cash processes. Because of this, we have unparalleled insight into the effects of automation on AR effectiveness, company financial performance, and customer and employee experience.

Here’s what some of them have been able to achieve:

• Automation rates in AR processes over 99%, with up to 90% of all inbound payments automated
  With 60% automation rates achieved in just 3 months
• Operational efficiency in AR processes improved by up to 89%
• 3x increased hit rates for automated processes
• DSO reduced by 85-95%
• Payment processing times reduced by up to 80%
• AR team productivity increased by up to 50%
• Apply cash in under 24 hours from time of payment
• Realtime KPI visibility
• Full cashflow insight

This allows for the scalable handling of extremely high volumes of invoices and payment requests with ease, and means vastly reduced error rates, as many invoices and payments are handled with touchless processing.

How can Serrala help you? 

Serrala’s AI-powered automation solutions are trusted by over 2,000 world-leading brands to achieve automation rates of up to 99% in their AR processes. Eliminating manual effort from many of their most important accounting functions and saving weeks’ worth of time across not just their AR teams, but their wider order-to-cash process, and experiencing the improved working capital that allows them to make key strategic investments and decisions more quickly and more confidently.

Our solutions are fully integrated with your current SAP environment (S/4HANA or previous systems like ECC) and embedded in SAP as an augmentation of SAP order management solutions, which means you can post and update data in SAP in real-time.

If you’re interested in learning more about what we can do for you, get in touch with us today to book a demo.