Accounts receivable is a record of any money that is owed to your business.
Allowing customers to purchase goods or services on credit can help to drive sales. Accounts receivable help you keep track of the credit you extend to customers. Once you invoice your customers, you would enter this information into your receivable accounts ledger.
If your business offers a credit service it will need careful management to ensure prompt payments are received. The mismanagement of these accounts could lead to late or default payments which will have grave effects on your business. It also gives you a more accurate record of your revenue.
Here is a quick guide on how to calculate and log accounts receivable for your business.
Using Accounts Receivable
There are a number of different methods available for recording your accounts receivable. These include offline entry systems such Excel, or specialized accounts receivable software. You could also choose to use an online accounts receivable tool.
There are many options to choose from.
Offline Accounts Systems
If you are considering using an offline system entering data into Excel, you have to set up the proforma yourself. To do this you need to include separate columns for:
- Date of purchase.
- Customer name.
- Unique invoice reference.
- Total due.
- Date due.
If you are using Excel, you will also need to design an invoice template and generate your own invoices. You need to keep one file for receivables and another one for paid invoices.
You will keep unpaid invoices in the accounts receivable file. You move them over to the paid file once payment has been received.
Using Software Programs
Specialized accounting software will generally include a receivable option. This makes your accounting much easier and more efficient. It will help you keep track of all the invoices and any payments which are owed.
You load all the customer details into the system along with sales information. The system will then generate invoices, either paper or digital (or both). You can choose to send them to customers manually in paper form or digitally, via email.
Using specialized software will allow you to run reports highlighting unpaid invoices.
Software programs are also capable of performing different types of analyses. They can provide separate information for those invoices that are late. This lets you follow the correct procedure for collection, depending on how late the payment is.
It is a good idea to issue your customers with a monthly statement. This will give them details of what they owe on outstanding invoices. It can show payments that have already been received. At the bottom of the invoice, there should be a total balance carried forward of money still owed.
Keeping Track of Accounts Receivable
Using software will save time by not having to enter information repeatedly across your records. It also reduces the chances of mistakes, which is vital when it comes to accounting. However, even if you don’t have software you must still keep an accurate record of all accounts receivable.
This is the process that is used, and the process you can follow if you don’t have software available. This process may be slightly different, depending on if you are selling services or goods.
Record Service Sales
These are the steps to follow to record a sale of services in sales and accounts receivable logs:
- Credit the sales account with invoice amount owed
- Debit account receivables for the identical amount
- Once the invoice is paid, debit the sales account and credit account receivables with the same total
If you invoice a customer for $3000 for services, you would enter that as a debit in your accounts receivable. You have thus increased your accounts receivable assets on the balance.
You also input the same amount of $3000 as a credit to your sales account. This then shows on your financial statement as an increase in sales.
Record Goods Sales
To record a sale of goods you would do the same as for services, but there is an extra step to include.
In this case, you also record the cost of the goods sold as a reduction in inventory.
You make a sales agreement for $8000 of which $6000 represented the actual cost of goods sold to the purchaser. As with the above, you would credit sales for $8000 and debit of $8000 to receivables.
You would then debit your price of goods sold for $6000. On your financial statements, this will then appear as a cost.
You also need to credit the inventory $6000. The inventory credit would then be reduced by $6000 on the balance.
Take Bad Credit into Account
When working with credit, you must assume that certain debts may never be paid. The best and correct way of accounting for bad debtors doing this is to estimate how many of your invoices won’t get paid. Add these estimates monthly to your journal entries.
Using this method of accrual allows you to keep a record of expenses for bad debt on a monthly basis.
As an example:
You assess that $30,000 of invoices will fail to be paid one month. You would record this amount in the unpaid debt expense account. On your financial statement, this then appears as an expense.
You would also make an entry of credit for $30,000 on the balance sheet for the accounts for unpaid debts.
You eventually identify the exact invoices that haven’t been settled. You will then record a debit in the accounts for unpaid debt and credit the account receivable.
Analyzing Accounts Receivable
When using accounts receivable you need to ensure that payments are received promptly. This means accounts need to be managed carefully to eliminate delayed or late payments.
A good way of doing this is is through analyzing financial ratios like average collection periods. Learning how to do this can keep you aware of how quickly payments will be received. This in turn will help your business stay on track.
The following equation is what is used to quickly calculate the average period of collection for accounts receivable:
Period = Days / receivables turnover
The number of days refers to days in the period being measured. Many businesses will use either a year or half year for this period.
Receivables turnover needs to be calculated from more data. For this, you need the measurement of net credit sales and balance of average accounts receivable for the period in question.
Both of these figures are easily accessed through the general accounts ledger.
Net credit sales equal all the sales which are given on credit minus the returns and allowances. Credit sales are all non-cash sales where the customer is allowed to pay at a later date.
Sales returns are where a customer has been issued a credit due to a problem with the purchase made.
Sales allowances are when reductions are given to a customer when there is a problem with the transaction.
By granting a large amount of credit to customers even to those with a bad credit history the company’s net sales will be higher.
The equation to use for this is:
net credit = sales on credit – returns – allowances
Average Accounts Receivable Balance
For the measurement period in question, you would use the month-end accounts receivable balances for each month in the period. This information is found on the balance sheets of the accounts.
If a business is rapidly growing or declining it should use a shorter period of measurement. Using a twelve-month period would result in overstating averages of receivables in a company that is declining. For a company that is growing, it will understate the average.
In either case, three months would be a good measurement of the period to use.
Accounts Receivable Turnover Ratios
This is the annual net credit sales of the company divided by average balance accounts receivable for the same period of time.
This calculation shows how many times the company’s accounts receivable turnover.
Using Accounts Receivable Data
Using this data tells a company how long customers are taking to pay invoices. A lower collection period is preferable, as this indicates the company is being paid promptly.
If the customers pay more promptly, there are fewer funds allocated to the accounts receivable. This means the company has more cash to available to spend. A low figure also means that you are dealing with customers who are less likely to default.
We hope that this information has given you insight into how to calculate and log accounts receivable and how to use the information.
Offering services and goods on credit allows you to attract a wider scope of customers. It is necessary to conduct good screening checks before offering credit, so make sure you have a robust application process.
Use the information that you can pull from accounts software to analyze your turnover ratios. Keep a close eye on how your business is doing. This will help you determine whether or not accounts receivable is a good option for your business.