Accounts receivable: how to manage them without dying in the attempt

One of the common problems that businesses struggle with is that customers almost never pay up-front for products or services and are sometimes late with payment. Debt accumulates and cash flow is jeopardised. The goal? Avoid aggravating accounts receivable problems. To that end, it is vital to optimise accounts receivable management to ensure that a business’s financial health stays strong.

What are accounts receivable?

Simply put, an account receivable is any invoice or payment that has not been received. But given the weight attached to this concept in business, it is helpful to explain that this accounting term refers to the amounts that a company expects to obtain from its customers for those services or goods that it has provided on credit. It is therefore a right that the company has to receive to receive future payment from the customer.

This debt that the customer owes may be short-term (less than one year) or long-term (more than one year), which is why sound accounts receivable management involves not only managing invoices correctly, but also building a relationship with the customer and engaging in constant communication to safeguard the flow of information.

Why does the accounts receivable process matter?

Whether it’s a missed deadline, a missed invoice or human error, accounts receivable can create a disruptive bottleneck for a business. Beyond being a cash flow issue, accounts receivable provides an at-a-glance analysis of the business’ finances.

A company’s immediate cash on hand, in other words, its liquidity, will depend on how well accounts receivable are managed. Liquidity is a financial concept that refers to an asset’s ability to be converted into cash without losing value, making it a fundamental cornerstone of the organisation’s ability to manage its financial obligations and safeguard the company’s financial solvency. Without it, efficient long-term financial planning is extremely difficult. Closely related to liquidity is another key indicator: the runway. This metric indicates how long the company can continue to operate with the cash or liquidity it has.

Classifying accounts payable

Taking a deeper dive into the subject, accounts payable fall under two broad umbrellas:

• Trade receivables. These are all invoices for goods or services that have been delivered but haven’t been paid for yet. They are a current asset and are expected to be paid in the short term. In turn, they are classified according to the time that has passed since the invoice was issued. These can be broken down into:
  • Current.  Those that are expected to be paid within a period of 30 to 60 days.
  • Overdue. Those that have not been paid after the due date. In doubtful loans, there is uncertainty as to whether the customer will pay.
  • Uncollectible. Those that are considered irrecoverable.
• Non-trade receivables. These are accounts receivable that are not related to the sale of goods or services and include credits granted to third parties, loans to employees, recoverable taxes, etc. On the other hand, they may also be associated with charges to affiliated companies or outstanding receivables for certain extraordinary services that are not usually part of the company’s core business.

Reducing risks, developing strategies and strengthening accounting management

You can apply several strategies to reduce the risks involved with such an important accounting issue, including:

• Pre-check a customer’s credit history and ability to pay. This will give an idea of their reliability, for example, whether they are listed in any default registers, their creditworthiness or whether they have a high number of outstanding receivables.
• Make a detailed, organised and timely invoice schedule to avoid errors or delays that can lead to late payments. This also involves good record keeping and document organisation to avoid misplacing invoices.
• Establish clear credit policies with specified payment terms and conditions and credit limits, since indicating the due date on invoices and purchase orders will help to avoid confusion. It is also important to review these conditions from time to time to review your financial capacity.

• Setting credit limits for each customer can help reduce the risk of non-payment.
• Optimise the days receivable outstanding (DRO) to provide the company with greater liquidity. The DRO is an indicator that reflects the average time in which the company finances purchases customers make on credit, that is, it measures the average number of days it takes for them to pay. It is also important to balance the DRO against the days payable outstanding (DPO), the average number of days a company needs to pay its bills and obligations, to have sufficient liquidity to meet payments in time.
• Using digital invoicing tools allows you to automate processes and implement practical solutions. There is a variety of accounting management software that can accurately record income and expenses, generate invoices, track payments and receipts, and even produce cash flow forecasts.
• Offer payment incentives, like discounts for early payment or cash payments, which can encourage customers to pay promptly. It is worth thinking about which customers this type of credit policies should be applied to, since they can be effective in specific cases (customers who have responded responsibly in the past) and are less recommended for customers who are late payers.
• Being flexible with payment methods helps to reduce potential problems, for example, by enabling online payment systems, cheques, cards, etc.
• In the latter case, it is advisable to temporarily stop working with late-paying customers and wait for them to settle their debts before resuming business with them.

Factoring and confirming, two key tools for accounts receivable management

There are two financial services—in many ways two sides of the same coin—that can be powerful allies when managing accounts receivable.

• Factoring is a mechanism through which a company assigns its invoices to a financial entity that advances the amount in exchange for a service fee and then manages the collection with the debtor. It is therefore a collection service that helps companies that need liquidity by providing it in advance.
• Confirming is a payment service and allows the management of invoices to be delegated to a financial institution.

BBVA Spark offers factoring and confirming services as part of its comprehensive range of financial services tailored to the needs of high-growth companies.

Controlling and managing accounts receivable properly helps to ensure the accounting health of high-growth companies. It requires a clear, efficient invoicing and collection process, but also a continuous assessment of customer credit risk. Effective control of this entire process helps companies to better plan their finances and reduce risks, supporting the core of the business.