Unless you deal only in cash sales, you will have customers who owe you money. Keeping track of these amounts is an important part of your record keeping. Accounts receivable is the sum of customer accounts that are outstanding. The more carefully you keep your books, and follow-up with customers with past due balances, the better you will be able to manage your company's cash flow.
Accounts Receivable on Your Balance Sheet
Accounts receivable is an asset on your balance sheet because it adds to your net worth. Prospective lenders consider accounts receivable when making decisions about your loan application. When a customer pays an invoice, the value of your accounts receivable asset will diminish but the amount of cash on your balance sheet will increase equally.
Accounts Receivable Turnover
Accounts receivable turnover is an accounting term that stands for the frequency with which customers pay what they owe you. Your turnover rate will depend on the terms that you extend to customers and on your effectiveness at collecting past due accounts. You may choose to use terms of net 15 or net 30, meaning that you allow your customers 15 or 30 days from the time of sale to pay. Establishing a shorter payment period helps with cash flow because you receive payment faster. However, allowing longer payment periods can be a useful marketing tool, making your business a more appealing choice for customers with cash flow difficulties and large companies who set their own terms, for example, 30 days or 45 days, and who pay hundreds of vendors. Whatever your payment terms, take care to keep thorough and accurate records of outstanding invoices and when they are paid in full.
Accounts Receivable Turnover Ratio
Accounts receivable turnover ratio is measured in the number of times per year that you receive the typical amount owed to you in accounts receivable. For example, if your customers combined typically owe your company an average of $4,000 at any point throughout the year and you collect $32,000 over the course of the year, your accounts receivable ratio will be eight because your average amounts receivable total is paid eight times over the course of the year. The less time you allow for your customers to pay, the higher your accounts receivable ratio. Accounts receivable ratio is also a measure of how proactive you are at collecting past due accounts. Increasing your accounts receivable ratio is an effective strategy for improving cash flow and attracting investors. A high ratio will also help you more readily secure a loan.
Improving Your Accounts Receivable Turnover Ratio
You can improve your accounts receivable turnover ratio by changing your terms to give your customers less time to pay. You can also increase this ratio by collecting diligently on past due accounts. Including past due balances on current invoices is a friendly way to remind customers of what they owe you. Sending monthly statements showing total outstanding invoices is an effective, nonaggressive strategy as well. In some cases, you may need to be more assertive and make phone calls or send emails to collect past due amounts owing. Keeping your accounts receivable current reflects a well-managed business, hence a healthy financial position.
Devra Gartenstein founded her first food business in 1987. In 2013 she transformed her most recent venture, a farmers market concession and catering company, into a worker-owned cooperative. She does one-on-one mentoring and consulting focused on entrepreneurship and practical business skills.