If you're running a business, you likely already know how important your accounts receivable are. After all, they represent the monetary amount owed to you by your customers. The amounts owed can be split into two different categories: debit and credit.
However, understanding what debt or credit means can be confusing. This article clarifies that confusion, breaking down how accounts receivable work in a business's account system. By the end, you'll understand how to handle accounts receivable so that your business is well-organised and financially healthy.
What are accounts receivable?
Your accounts receivable refers to the money customers owe to your business. This can include customers who have placed an order and are awaiting payment or those with existing invoices that are yet to be paid.
Essentially, account receivables are a record of all the debts clients owe to your business based on products or services sold.
As accounts receivable contributes to a healthy cash flow, keeping track of them is essential.
Accurate record-keeping of your accounts receivable also enables you to keep track of which customers are slow to pay and lets you politely remind them if necessary. In short, it can help to ensure prompt payment moving forward.
What is the difference between a debit and a credit?
Foundational concepts in account, a debit and a credit are two types of data entries that will be recorded in your accounts receivable ledger. Though they are the opposites of each other, it's important to understand their differences and the impact they have on your business operations.
Debits refer to an increase or addition of assets or expenses, while credits refer to a decrease or subtraction of liabilities, assets, or income.
In other words, a debit entry is noted on the left side of your accounting ledger, and credit balances are on the right.
As your AR team makes entries into the ledger, it's important to remember that debit always increases an asset or expense account while a credit decreases them.
Debits and credits affect different types of accounts differently. For example, revenue accounts will increase when credit is applied, while an asset account increases with a debit entry. An inventory or cash account, however, are the only two types of accounts that increase and decrease with debits and credit.
Are accounts receivable debit or credit?
When it comes to determining whether your accounts receivable are debit or credit, the answer is both, which can get confusing.
When a customer places an order, the accounts receivable account is credited on the right side of your ledger. This indicates that money will soon enter your business as payment for goods or services provided.
However, when you receive the payment from a customer account, it will then be debited to the account receivable column on the left side of your ledger. This indicates that money is entering the business to pay off a debt.
So, as you can see, accounts receivable are both debit and credit entries in your ledger since they involve two differing kinds of payment transactions.
How to apply a debit or credit to accounts receivable
Applying a debit or credit to your accounts receivable is a simple process. For accounts receivable debit, simply add the payment amount to the left side of the ledger (the debit column).
For accounts receivable credit, subtract the amount from your credit balance on the right side of the ledger (the credit column).
It is also important to ensure that all your entries are accurate and up-to-date. Any discrepancies in the AR process, such as an incorrect credit balance or omitted accounts receivable entries, can affect the accuracy of your financial reporting and potentially lead to legal issues.
When do you use a debit or credit for accounts receivable?
When working with accounts receivables, you should use credit when creating an invoice or entering a bill since this increases the money owed to your business for your products or services.
You will then use debit when payments are received from customers. This decreases the amount of money that was initially owed to your business, bringing the balance back down to zero.
It's also important to note that payments are not always received in full. In this case, you should use debit for the amount of payments received and leave the outstanding balance as a credit.
Good record-keeping is essential
When it comes to managing accounts receivables, good record-keeping is key. The more organised you are, the easier it will be to track outstanding payments, and facilitate a healthy cash flow.
If you're using an accounting software system, make sure to regularly update the entries in the ledger so that the data isn't outdated or inaccurate. You should also periodically review your ledger to ensure that your business's financial health is stable.
What to remember when handling accounts receivable
Now that the basics have been covered, here is a quick recap of the key points to remember when managing accounts receivable:
- Accounts receivable represents the money owed to your business by customers and represents a critical part of your billing and collection processes.
- Debits and credits are two separate entries made on the left and ride sides of your ledger respectively.
- Debit entries increase assets or expenses, while credits decrease them
- Accounts receivable are debits and credits since they involve two different types of transactions: the customer ordering goods and services and then paying for them.
- When applying a debit or credit to your ledger, remember to add amounts on the left (debit) side and subtract amounts on the right (credit) side.
- Always make sure your entries are accurate and up-to-date.
Following these steps will help you stay organised and ensure that your business is in good financial health.
Why account receivable management is so critical
When it comes to the financial health of your business, effective AR management is crucial. Not only does it help you to keep track of payments and cash flow, it also makes it easier to identify customers who are slow to pay.
In these cases, you can send out a reminder or add interest to the corresponding invoice if payment is not made within a specified period. With the right account receivable system in place, you can maximise your profit potential by getting paid quickly.
There are a range of tools and strategies you can employ to help you stay on top of the accounts receivable process, including:
Automation
Effective management of your accounts receivable is vital and resource-intensive. Employing automated accounts receivable software, like Chaser's market-leading platform, can save you a great deal of time and effort.
From sending automated payment reminders to providing actionable insights to improve your processes, these automated tools can help you reclaim the time you currently spend chasing payments for services delivered.
Early payment discounts
Offering early payment discounts for customers is a great way to incentivize prompt payments. This will enable you to get paid faster and help free up cash flow that would otherwise be tied up in receivables.
You can also implement late payment fees for customers who are slow to pay. This will reduce the amount of time you have to spend chasing payments and generate additional revenue.
KPI tracking
Key performance indicators (KPIs) are a great way to track your accounts receivable performance.
By measuring metrics such as payment frequency, customer delinquency, and average collection period, you gain valuable insight into how effective your receivables management process is and can identify areas that need improvement. It could be that you need to update your billing and collections processes or manage bad debt.
Credit Terms.
Credit terms are the payment deadlines that you set for customers. Setting clear and reasonable terms ensures payments are received on time and without dispute. Establishing favorable credit terms can also help to improve customer satisfaction rates, as they better understand the billing process.
You should review your credit terms periodically, especially if you've noticed an increase in late payments. This way, you can make adjustments that will improve your accounts receivable balance.
Keeping on top of your cash flow
Accounts receivable management is essential for any business that wants to remain financially successful. By following the steps outlined above, you can ensure that your ledger is accurate and up-to-date, which improves your overall financial performance.
Conclusion
Accounts receivable are an important part of any business's finances, so it's crucial to understand how to manage them correctly.
By understanding the basics of debits and credits, creating accurate entries on your ledger, and staying organised with your record-keeping, you can ensure that your accounts receivable remain in equilibrium and your business's financial health is stable.
A proper accounts receivable process enables you to keep a close eye on how much money is coming into and going out of your business. This will help you remain financially secure while growing and scaling your business.
For more information on effectively managing your accounts receivable, check out Chaser's blog. For an insight into how Chaser's automated platform can help you streamline your accounts receivable system, book a demo today or sign up for your no-obligation 10-day free trial.
