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Accounts Receivable Management: What It Is, How to Improve It

  • 17 min read

Accounts receivable management is the process of monitoring and controlling money customers owe to a business for goods or services purchased on credit. AR management ensures a company receives timely payment.

Person sits before a floating screen showing invoices and a pie chart

Good accounts receivable management policies can increase cash flow, improve collection processes, and get your company paid faster. They can also substantially boost your customers’ experience.

Likewise, poor practices can hinder organizational growth.

Many organizations still rely on manual invoicing, phone follow-ups, and archaic data systems. Meanwhile, companies that are digitizing and automating accounts receivable management tasks are leaving competitors in the dust as they leverage automation to boost cash flow and enable future growth.

Before moving processes online and automating tasks, it’s essential to understand your organization’s entire accounts receivable process to gauge areas for improvement.

Jump to a section of interest:

    What is accounts receivable management?

    Accounts receivable management is the process of monitoring and controlling money customers owe to a business for goods or services purchased on credit. AR management consists of policies and procedures that maximize account management efficiency and minimize the risk of bad debt.

    AR management ensures a company receives timely payment. This involves AR teams:

      The impacts and benefits of AR management

      Accounts receivable management significantly impacts many aspects of business operations. When implemented correctly, it can generate positive outcomes for:

      • Cash flow management
      • Customer relationships
      • Account reconciliation
      • Vendor reputation
      • Employee experience

      Maintaining positive cash flow is always important, but even more in times of economic volatility, company growth, or unexpected events. AR automation software can streamline AR management processes to quickly increase cash flow by automating payment collection, financial reporting, and other activities that manual collections tend to inhibit.

      Good AR management solutions and practices also allow businesses to accurately create, issue, and recall invoices—and supporting documentation—and avoid payment disputes, whether from communication misunderstandings or collection errors. Effective dispute management practices—a facet of AR management—strengthen customer relationships and enhance loyalty over time.

      Keeping timely, accurate transaction and payment records is central to accounts receivable management, too. Doing so ensures account balances are up-to-date and makes account reconciliation smoother. An effective accounts receivable management system also strengthens your business’s reputation and builds strong relationships with customers by ensuring their payment experiences are memorable and easy.

      Finally, optimized AR management creates a more efficient accounting team focused on strategic initiatives rather than administrative duties. The result? Higher employee satisfaction and better strategic outcomes.

        How to optimize your accounts receivable process

        The accounts receivable process has eight steps:

        1. Customer places an order
        2. Company approves customer for credit
        3. Company sends the invoice
        4. Company manages collections
        5. Company investigates and addresses disputes
        6. Company processes payment
        7. Company posts payment to corresponding invoice
        8. Company reports on the AR status (ongoing)

        Better AR management equals a more optimized and streamlined AR process, which leads to the following benefits: reduction in manual tasks, easier payments, better dispute resolution, and increased cash application efficiency. Let’s explore how effective AR management drives these benefits.

          Effective accounts receivable management software reduces manual tasks

          By automating accounts receivable—one of the most effective methods of optimizing your AR management—companies can significantly reduce manual tasks associated with the above eight steps. Accounts receivable automation software can:

          • Deliver electronic invoices directly to customers upon creation in the ERP
          • Send automatic reminders on your behalf before and after invoices are due
          • Process incoming digital payments
          • Automatically match payments to open invoices
          • Automatically post payments back to the ERP

            Effective AR management enables easy payments

            Companies get paid faster when customers can have transparent access to their account, view invoice statuses, and easily make online payments. Organizations that still rely on manual invoicing techniques—and subsequently maintain poorer AR management processes—limit their cash flow and growth.

            What makes paying online “easy”, you ask?

            • Granting your customers access to an online, cloud-based payment portal
            • Empowering customers to pay in full, partially, or for individual line items/multiple invoices at once
            • Allowing customers to automate recurring payments and leverage credits
            • Accepting all preferred payment options like credit, debit, ACH, virtual cards, bank payments

              Effective AR management resolves disputes effectively

              Fifty-five percent of AR professionals say dispute management is their most difficult task. Making this AR management process easier can improve both employee happiness and resource management internally, and customer experience on the external side.

              A collaborative approach can streamline dispute resolution and help companies get paid faster. Effective dispute resolution relies on:

              • Prioritizing claims as soon as possible so disputes don’t drag on
              • Taking internal action first to research disputes before getting customers involved
              • Maintaining effective communication channels
              • Thoughtfully communicating decisions to customers
              • Keeping customer records current and accurate

                Effective AR management improves payment application

                The cash application process—a core tenet of accounts receivable management—is notoriously difficult, so most AR teams have a lot of room for improvement. Automating cash application through machine learning enables companies to match any payment type with an open receivable, capture and reconcile payment data, eliminate manual entry, and speed up cash flow.

                An all-in-one cash application accounting software solution can automatically extract remittance data from multiple sources including emails, vendor portals, PDFs, bank lockboxes, and more using advanced image recognition. An effective accounts receivable system helps teams save time and improves customer experience.

                3 factors that complicate accounts receivable management

                A common misconception is that the biggest accounts receivable challenges are related to late payments or high DSO. These are actually consequences of having poor AR management processes in place.

                The root challenges to overcome with accounts receivable management include:

                • Poor communication between your AR team and your customers
                • Traditional—manual—AR processes
                • Lack of real-time and historical data

                  1. Poor communication between your AR team and customers

                  The dreaded AR Disconnect. When miscommunication happens between a company and a customer during the payment process, it’s typically due to lack of transparency into receivables, reliance on manual workflows, and ineffective communication methods.

                  Poor communication can manifest in several ways, such as sending invoices that lack proper documentation or go to the wrong contact. To AR teams, it can look like a check that was “lost in the mail,” unexplained short payments, or payments sent with incomplete remittance information.

                  This creates more account management work for AR teams and a negative customer experience. At its worst, it can even lead to litigation.

                  2. Traditional AR processes are inefficient

                  Traditional AR management processes are inherently inefficient. They require significant manual effort that leads to errors like inaccurate data entry, delayed invoicing, miscommunications, late payments, and ineffective follow-up. Individual phone and email outreach or physically mailing paper checks and invoices can grind collection processes to a halt.

                  3. Data is hard to find and evaluate in real-time

                  Most AR teams must navigate a patchwork of legacy systems, reports, spreadsheets, and tools to retrieve data and complete work. Siloed, hard-to-find data prevents learning from real-time and historical data.

                  Without real-time metrics, AR professionals can’t advise the sales department on credit terms. They can’t update the collections team on outstanding accounts. And without historical data, teams can’t accurately forecast customer payment issues, which generates more work when disputes arise.

                  How to measure performance of AR management

                  Companies can’t fix what they can’t measure, which is why companies must evaluate their AR performance to accurately assess their accounts receivable management performance. The most prominent AR metrics are day sales outstanding (DSO), collection effectiveness index (CEI), accounts receivable turnover rate, and average days delinquent (ADD). We will go into each of these in more detail.

                  Additionally, other metrics that can add value for AR teams include: expected cash collections; average collection period; number of revised invoices; bad debt; percentage of high-risk accounts; staff productivity; and customer satisfaction.

                  How DSO measures AR management performance

                  Day sales outstanding (DSO) is the average number of days it takes for a company to receive payment after making a sale on credit. DSO is also known as “average collection period” or “days receivable.” DSO measures how long it takes a company to receive payment.

                  A low DSO is a positive metric, meaning a company quickly collects payment from customers paying on credit. A high DSO means the opposite and can signal opportunities for improvement in your accounts receivable process.

                  To calculate a company’s DSO, divide the total receivables due by total net credit sales, then multiply that by the number of days in the calculation period.

                  • Day Sales Outstanding = (Accounts Receivable / Total Net Credit Sales) x Number of Days

                  How CEI measures AR management performance

                  The collection effectiveness index (CEI) calculates the percentage of receivables a company collects during a given period. CEI assesses collections efficiency over both regular intervals and long periods of time.

                  A high CEI can indicate successful AR management strategies. A low CEI can suggest that manual invoicing, rigid payment terms, or communication challenges are hindering a business’ invoice-to-cash process.

                  To calculate CEI, add your beginning receivables and monthly credit sales, then subtract ending total receivables. Then divide that by the sum of beginning receivables and monthly credit sales, minus ending current receivables. Finally, multiple that number by 100 to get the percentage.

                  • [(Beginning AR + Monthly Credit Sales) - Ending AR] / [(Beginning AR + Monthly Credit Sales) - Ending Current AR] x 100

                  How ARTR measures AR management performance

                  Accounts receivable turnover ratio (ARTR) refers to the number of times during a given period (month, quarter, year) a company collected its average accounts receivable. This is an efficiency metric and is also called “receivables turnover ratio” or “debtor’s turnover ratio.”ARTR shows how quickly a company converts receivables into cash on average. ARTR provides a general expectation of when receivables will be paid and helps improve balance sheet forecasts and spending plans. A high AR turnover ratio indicates a company collects debts efficiently and is likely in a healthy financial position. A low ratio can signal trouble and opportunities for AR process improvements. Here’s how to calculate accounts receivable turnover ratio:

                  1. Determine net credit sales—Net Credit Sales = [Sales on Credit - (Returns + Sales Allowances)]
                  2. Calculate average accounts receivable—Average Accounts Receivable = [Starting Receivables + Ending Receivables) / 2]
                  3. Divide net credit sales by average accounts receivable—ARTR= Net Credit Sales / Average Accounts Receivabl

                    How ADD measures AR management performance

                    Average days delinquent (ADD) measures how late customer payments are on average at a particular moment in time. This metric only looks at late payments.

                    A high ADD is undesirable. High ADD rates indicate customers are slow to pay. A lower ADD means customers remit faster and is a sign of effective AR management practices. ADD is most valuable when evaluated as a trend over time and in comparison with other metrics, like DSO.

                    To calculate average days delinquent, calculate DSO and best possible days outstanding (BPDSO), which represents the most ideal timeline that a company can expect to collect payments.

                    After calculating DSO (see formula above), calculate BPDSO with the following equation:

                    • BPDSO = (Current Accounts Receivables / Total Net Credit Sales) x Number of Days in Period

                    To calculate average days delinquent, simply subtract BPDSO from DSO:

                    • ADD = DSO - BPDSO

                    What are accounts receivable management best practices?

                    Best practices for a successful accounts receivable management strategy include:

                    • Extending credit to customers
                    • Sending invoices quickly
                    • Providing multiple payment options
                    • Defining clear billing procedures
                    • Ensuring clear communication
                    • Using collections email templates—in lieu of full-fledged automation
                    • Automating everything you can—in service of transforming your AR processes

                    Extending credit to customers improves AR management

                    A credit policy documents how a company extends credit to customers and collects delinquent payments. A comprehensive credit policy protects companies from late payments and maintains healthy working capital. A credit policy should include:

                    1. Terms of sale:How much credit can be extended to customers and related terms
                    2. Credit extension: How to evaluate credit criteria for customers
                    3. Collection process: How to collect past due invoices
                    4. Clarification on:
                      1. Credit limits
                      2. Payment terms
                      3. Accepted payment methods
                      4. Required customer data
                      5. Bad debt policy

                    It is best practice for a business to be discrete about which customers they will extend credit terms to when drafting a credit policy.

                      Sending invoices quickly improves AR management

                      Generating and delivering invoices quickly is a key driver to getting paid faster. Companies that still manage invoices manually are inhibiting their AR process and should implement automated invoicing as quickly as possible.

                      Versapay offers a collections automation solution that enables AR teams to segment customers and tailor communications, view all customer invoices, see when customers open invoices, and track DSO and overdue invoices all in one place.

                      For unpaid invoices, Versapay generates automated dunning letters—notifications—to expedite payment collection. A dunning letter is a collection notice that alerts a customer to overdue payments. Dunning letters prevent delinquent accounts and help manage DSO.

                      Providing multiple payment options improves AR management

                      Providing multiple payment options allows customers to remit with their choice method, giving them fewer excuses for failing to pay.

                      Your AR management process should offer customers the following payment options:

                      • Credit card
                      • Debit card
                      • ACH
                      • Virtual cards
                      • Bank payments

                        Defining clear billing procedures improves AR management

                        Clear billing procedures define expectations internally and externally. Perhaps even more important than the initial definitions is consistent adherence across the AR team.

                        Establish clear payment terms, such as due dates, grace periods, and late fees, and clearly communicate these terms to customers. Develop a standard invoicing process with templates and numbering conventions for consistent, accurate billing.

                        Ensuring clear communication improves AR management

                        Clear communication is critical to an optimized collections process and good customer experience. Set and communicate clear expectations, especially around payment terms. Put them in writing and make them easily available to team members and customers.

                        Provide contact information on customer-facing materials so customers know who to reach out to with questions. Respond promptly when inquiries come in. Accounts receivable software can greatly streamline internal and external communications with electronic invoicing, automated reminders, and by providing shared access to a cloud-based portal containing all invoices, account statuses, payment methods, and more.

                        Using collections email templates improves AR management

                        Email templates help relay consistent, applicable information. An AR collections email template is standardized across teams but can be tailored to a particular situation, recipient, or need. Using email templates can save staff time, reduce costs, improve customer service and experience, and reduce errors.

                        Automating everything can improve AR management

                        Accounts receivable automation alone cannot drive significant change if existing processes are flawed–but it’s certainly a great place to start. Companies may need to redesign their AR processes to ensure optimal success. From there, they should automate every step possible to fully realize the benefits of AR transformation.

                        By implementing automation into effective AR management strategies, organizations will quickly increase ROI and can focus on providing better customer experiences by reducing manual administrative tasks and reducing areas of friction.

                        What about accounts receivable management software?

                        Cloud-based accounts receivable automation technology improves AR management processes by enabling greater collaboration—between AR and AP teams—flexibility, efficiency, scalability, and an improved customer experience. These AR management software tools go beyond automating manual tasks, to relieve significant pain around wasted time, underutilized talent, delayed payments, and customer miscommunications.

                        How to choose accounts receivable automation software

                        Choosing the right AR automation software solution requires buy-in across everyone involved in the AR process. Remember: accounts receivable automation software is not created equal. With an ever-changing and growing marketplace, it’s critical to find a tool that not only fits existing needs, but will also support future growth and innovation.

                        Companies should consider 12 components when evaluating AR automation software to boost their AR management processes:

                        1. Invoicing and statements
                        2. Payments
                        3. Collections
                        4. Deductions and dispute management
                        5. Customer analytics
                        6. Cash application
                        7. Collaboration and communication
                        8. Customer experience
                        9. Customer adoption
                        10. Ongoing support
                        11. Security
                        12. Cost

                        To assess how your AR processes stack up and receive tailored suggestions for improving accounts receivable management, get your own AR transformation roadmap. Just answer a brief assessment and you’ll get a unique roadmap to help you improve your AR processes today.

                          About the author

                          Ben Snedeker

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