Corporate Tax Filing Guide for Businesses and CFOs
Corporate Tax Filing Guide for Businesses and CFOs If you want to grow a financially-healthy
Many businesses offer credit terms to their customers, meaning they provide the goods or services now and collect payment later. This model comes in handy when trying to boost sales and customer retention – which is why most businesses use it. Now let’s look at what accounts receivables are about.
When selling on credit, businesses must monitor all the money their clients owe. That’s when accounts receivables come in. If you’re wondering how AR works, how to keep track of them, and how to measure their performance, this article is for you.
Accounts receivable (AR) is simply the amount of cash your customers haven’t paid yet from past purchases. During a credit sale, your customers take your goods or services along with an invoice. Instead of paying you on the spot, the customer will pay on an agreed-upon date in the future, typically after a few weeks. All of that uncollected money gets recorded as accounts receivable.
Say you’re running a company that fixes commercial roofs. Here’s how AR runs from beginning to end:
Here are examples of what AR entries will look like in your general journal:
Company XYZ sells consumer goods in bulk. They sold their goods to a local department store on 10 January. The sale amounted to $30,000.00, which the store must pay within 30 days.
The credit sale transaction must be recorded in this way on the journal:
After 30 days, the store has made a full payment of $30,000.00. Company XYZ must also record this cash payment transaction:
In this example, the $30,000.00 payment gets credited in the accounts receivable balance and debited from cash. The $30,000 amount gets removed from AR and added to the company’s total cash balance.
Using the example above, say after 30 days, the store only managed to pay $15,000.00 instead of the total balance of thirty-thousand.
This is how it’ll go on the journal:
The process goes like in example B, but instead of recording the full amount, the company only registers $15,000.00. The company added $15,000.00 to their cash account, but another $15,000.00 still remains in accounts receivable.
Monitoring and examining AR allows you, your team, investors, and creditors to gauge your company’s future cash flow, liquidity, and overall financial stability. AR that piles up is never a good thing and is the main reason why many companies experience cash shortages.
Sound AR management requires staying on top of relevant metrics and KPIs. Two of the most important metrics in analyzing AR performance are the accounts receivable turnover ratio and collection period.
The accounts receivable turnover ratio measures how often you’re collecting outstanding receivables. Here is the AR turnover formula:
Example 1:
Company XYZ had a net credit sales of $1.7M and an average AR balance of $200,000 over a prior 12-month period. Using the accounts receivable turnover formula shown above: $1,800,000/$200,000, we get 9. Company XYZ 9 collected its average AR 9 times during the prior 12-month period.
The AR collection period tells you how quickly you collect what customers owe.
Example 2:
Since Company XYZ had an accounts receivable turnover of 9 over the last 12 months (365 days), we can easily calculate its AR collection period. Using the formula above: 365/9 gives us 40.5. Company XYZ took 40.5 days on average to collect what its customers owed over the period.
When it becomes evident that a customer won’t be able to pay, such as when their company goes bankrupt, you’ll have no other choice but write off the accounts receivable balance.
Using the example above, say after a couple of months, Company XYZ still hasn’t gotten any payment from the local store where they sold their consumer goods amounting to $30,000. After doing a bit of digging, the company found out the store had already closed down, leaving no chance of fulfilling the obligation. Company XYZ decides to write off the balance, deeming it uncollectible.
In this case, the written-off amount of $30,000 gets reported as bad debt expense, which will appear in the income statement under Operational Expenses. The company then removes the exact amount from the balance sheet’s account receivable balance under current assets.
Staying on top of accounts receivables is all-important if you’re going to stay liquid in the long run. We’ve laid out some proven strategies for you to control your cash flow like a complete pro. So head on over to that post to make sure you always know how to keep your cash flow pumping.
Failure to collect AR is one of the reasons why many companies fail. Cash remains king, and managing cash flow should be top priority for any business. Cash management practices and technology have come a long way. With today’s technology, you can automate cash management and AR tasks, cutting down work hours and spending by a huge margin.
With cash management software, you can automate invoicing, reminders, recording, and forecasting. You’ll also have the tools to get paid faster and easier. Peakflo does all of that and more. We’re also 100% free forever.
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