What is the Accounts Receivable Cycle?

The accounts receivable cycle starts when a service/product has been delivered, but not yet paid for, and is completed when the invoice is settled, and the amount paid in full. 

Accounts receivable is a necessary step in accounting because companies will often make arrangements to accommodate different payment scenarios and credit terms. 

In general, accounts receivable describes the money owed to a business, after credit is extended to the customer, and the product/service has been received. It’s a way of leveraging sales, improving consumer relationships, and building credit over time. 

Here we’ll examine each step in the AR cycle, including:

#1) Create a credit application process

#2) Send invoices to customers

#3) Establish payment terms and due dates

#4) Monitoring and reporting

#5) Recording AR activity

What is the Full Cycle of Accounts Receivable? 

The full cycle of accounts receivable starts at the sale and delivery of a product and/or service to a customer. It ends when that customer is invoiced and pays the amount owed. Everything in between is important in the process of ensuring you get paid, on time, with a healthy inflow of cash.

The purpose of the accounts receivable cycle is to bring consistent money into the business from goods/services sold. It works to avoid bad debt by collecting on invoices before they are past due. This business process provides a healthy cash flow that supports growth and profitability.

Managing the lifecycle of accounts receivable involves encouraging clients to pay, sending invoices and payment reminders, maintaining the trial balance sheet, and monitoring progress. 

The actual cash collection cycle equates to the number of days it takes to collect accounts receivable. This metric helps to track the ability of a business to grant a reasonable amount of credit to customers, and then collect receivables in a timely fashion.

The following are the most crucial steps in the accounts receivable cycle that delineate the workflow, from beginning to end.

Steps in the Accounts Receivable Process

These five steps provide a foundation for managing an efficient accounts receivable process, whether it’s a small business or enterprise organization.

#1) Create a Credit Application Process

If a business wants to extend credit to customers, there must be a way to safeguard the process. Boundaries should be set and policies put in place to protect the business and mitigate risk. 

Failing to make distinctions beforehand can result in delayed or missing payments, and may hurt customer relationships. 

To ascertain creditworthiness, consider a few of these questions to prepare a credit policy:

• What are the terms and conditions of your average sales?
• Is every customer eligible for the credit system?
• Are there any requirements before a customer is eligible for credit?
• What will the entire credit approval process involve? Who will oversee it?
• Are there any instances that would mandate immediate payment?

It’s important that everyone in the business is on the same page. From sales and marketing to HR and accounting, people should be aware of what to do to ensure positive cash flows. 

#2) Send Invoices to Customers

Customers who have requested credit for a sale, should anticipate an invoice next. A business must always stay on top of invoice processing. All documentation should be sent out as soon as possible to avoid late payments and outstanding invoices. 

This is a standard practice in any accounting system because customers are waiting for a final amount before issuing payment. It’s the prolonged follow-up to a sale after credit has been issued. 

Invoice methods can include:

• Paper invoices
• Electronic invoices 
• Financial statements
• Recurring invoices

The collection process cannot proceed without invoicing customers first. Otherwise, what will you collect on? Developing an organized process for invoicing is critical for an effective accounts receivable cycle.

#3) Establish Payment Terms and Due Dates

A business must clearly define when invoices are due, in order to be paid on time. This is something that’s usually set out during the initial sales contract, prior to extending credit or sending invoices. 

Payment plans defining the due date of invoices with the amount of money and the amount of time is something that should be established early on.

A decision must be made about what payment terms will work best for the accounting department and bookkeeping process. While most companies choose net 30 terms (due in a month), other businesses need cash upon receipt. In this case, payment options for early payment are crucial.

All invoices should state due dates in a highly-visible spot so that customers understand their obligations. Even with stringent terms, AR may need to paper chase on occasion. Don’t be afraid to adjust these terms based on customer behavior— whether you shorten or extend them. Otherwise, assets can turn into liabilities, and vice versa.

#4) Monitoring and Reporting

The closer you keep track of invoices, the easier accounts receivable management becomes. Monitoring the age of each invoice is essential for success. The “age” is how many days have transpired since the invoice date. 

The exact process of monitoring and reporting for AR may differ by the size of the company. This is mainly due to the number of resources, staff, and time available. 

Regardless, a designated team member should be assigned to report on things like:

• Outstanding and past due invoices
• Recently paid invoices
• The trial balance sheet
• Reconciliation of assets

Specific analytical tools, like the accounts receivable aging report, make it easier for a business to monitor and track the average length of time between initial invoice and payment. 

Different types of accounting software can optimize the collection process and ensure more payments get in on time. 

#5) Recording AR Activity

The AR cycle is not complete without recording specific accounting actions. This includes all payments coming in, when they are received, who still has outstanding debt, and invoices that remain unpaid. 

Incoming payments should always be recorded, either manually or through an accounting program. All specific numbers (invoice number, purchase order, shipping receipts, etc.) must be matched. 

In reality, every business will have one or two invoices that never receive payment. In these instances, proper documentation is crucial to write-off debt. Reporting is also necessary so each account (including credits, debits, liabilities, and assets) represents information in real-time. 

The accounts receivable representative or collections agent typically updates the balance sheet, any spreadsheet or journal entry, adjusts bad debt, and accounts for all unpaid invoices.

Benefits of Automating Accounts Receivables Cycle 

There is a lot to keep track of when managing the accounts receivable cycle. If the volume and complexity of invoicing consumes too much time, it may be wise to consider AR automation to free up resources. 

There is a multitude of benefits to digitizing accounting, especially receivable collections. Some of these include:

Security and Compliance

Businesses are facing all kinds of new security risks and invoice fraud every day. Paper and e-mail-based accounts receivable cycles are much more susceptible to hackers, phishing attacks, data breaches, fraudulent invoicing, and GDPR non-compliance. 

An automated AR solution sends 100% of your invoices electronically through a single provider, regardless of the delivery method or customer’s industry, size, or location.

Modern compliance can be complicated—especially with global commerce. Location-specific regulatory mandates change depending on your customer. E-invoicing enables real-time, electronic submission to the proper authorities, ensuring tax compliance, legal security, and cost reductions. This extends to archiving all documents as well.

Speed and Efficiency

When it comes to speed and efficiency, automation wins every time. The average manual process takes 50 to 72 days per invoice. Quicker invoice creation equates to faster payment collection, with shorter days sales outstanding. 

Invoice processing through automated solutions like Tipalti skips all the legwork. A typical process goes like this:

1. Submit invoice in a preferred format
2. Processing begins immediately
3. Invoice is translated, enriched, and validated
4. Documents delivered directly to buyers
5. Archived to meet regulatory requirements

This all takes mere minutes as opposed to days, weeks, or even months manually. A recent study showed a typical AR employee can process between 7,500 and 30,000 paper invoices per year, compared to more than 125,000 electronic invoices. This equates to 17 times greater efficiency than the traditional AR process.

Consistency and Accuracy

Automating the entire accounts receivable cycle leads to a higher rate of accuracy and consistency. It gives a business a more standardized process for consistency in cash flow with accurate data analysis and real-time reporting. 

Automation also means less manual errors and guaranteed invoice delivery. There is no more “getting lost in the mail.” When the entire AR cycle is automated, there is end-to-end process visibility for the entire accounting team.

Cash Management

With any form of automation, there will always be cost savings. Tasks are performed quicker, with less errors, and more efficiency. In a traditional, paper-based AR approach, employees spend a large amount of time laboring over each invoice, responding to customers, handling exceptions, recording data—the list goes on. Automation cuts through all of that.

AR automation frees up the accounting team to focus on more value-add tasks and increase the working capital. It helps to reduce expenditures on labor, printing, supplies, and mailing overhead. It can save 60%-80% on every invoice and generate a greater amount of liquidity. 

Additionally, ad hoc reports, real-time dashboards, and other automated tools provide transparency across the enitre AR cycle, allowing instant access to critical data. This includes information needed for forecasting, like:

• Delivery status
• Payment due dates
• Amount owed
• Performance over time

The right automated AR platform will deliver key insights and uncover every opportunity for a business to improve cash management. 

Additional Benefits:

• Improved customer relationships
• Less exception handling
• Develop workflow automation strategies
• Streamlined customer experience
• Higher finance staff retention rates

In Closing

Unlike accounts payable, the accounts receivable cycle focuses on bringing cash in, rather than sending it out. Strong policies and consistent management ensure the accounts receivable cycle is streamlined, outstanding invoices are paid, and ongoing business relationships are nurtured. 

One way to streamline operations and ensure quicker payments right now is to automate the entire accounts receivable cycle. Not only does this shorten the entire lifecycle, receivable automation also leads to fewer inefficiencies, more accurate reporting, and a higher rate of staff retention.