According to ING, accounts receivable is the largest or second largest account on most companies' balance sheets. The account represents all outstanding trade credit, other monies that need to be collected and obligations such as promotional credits and overpayments. Since it is the last step in the order-to-cash cycle for businesses, there are many reasons why monitoring accounts receivable is important.
Improve Cash Flow
Accounts payable, inventories and accounts receivable are all key elements to a company’s cash flow. In the order-to-cash cycle for a business, raw materials are bought and monies are owed to vendors through accounts payable. Raw materials are converted and stored for sale in inventory. Once sold, accounts receivable converts revenues into cash on hand. Each of these steps is important, but accounts receivable is the critical step that turns accounting money into real cash. Failing to monitor and ensure that the accounts receivable function is efficient will lead to less available cash for business activities.
Improve Cash Management
In relation to cash flow, lack of cash on hand will impact a company’s ability to manage operations. As sales are converted to cash, cash is then put to use buying more materials for inventory. If companies can turn around receivables faster than their payables, positive working capital will result. Poor accounts receivable monitoring can lead to a scenario where payables outpace receivables, forcing you into inventory financing. This adds unnecessary costs to selling product.
Deter Bad Debt
Sales may have been booked, but until a receivable is collected there is the potential that profit and loss will be impacted in the future. The longer receivables are outstanding, the less likely they will be able to be collected. Once a receivable is deemed uncollectable, it is expensed against gross profit. Monitoring accounts receivable and your aging of accounts will help you identify companies that do not pay their bills, preventing possible future bad debt.
Avoid Unclaimed Property
As of 2011, troubled states are turning to unclaimed property laws as a way to boost revenues. Unclaimed property can impact accounts receivable. Any overpayment that has aged a specified amount of time needs to be reported and transferred to the state in which a customer resides. Otherwise, you may be subject to an audit and subsequent interest and penalties. These laws are difficult to navigate as every state has different requirements. Monitoring accounts receivable to remove outstanding credits is the only way to avoid being subject to these laws and reporting.
Shaun Fowler is the author of a personal finance blog. He works full-time as a financial analyst while completing a Master of Business Administration in accounting.