Accounts receivable is about the survival of your business. No two ways about it. Cash flow problems almost always start here. Every unpaid invoice is like a hole in your ship, slowly sinking your ability to pay suppliers, invest in growth, or even meet payroll.
Read: A Complete Guide to Financial Statement Analysis for Strategy Makers
If managing your AR feels like herding cats—late payments, endless follow-ups, or customers who “forget” they owe you—then it’s time for a change. This guide will show you exactly what’s holding you back and how to fix it. From key AR metrics to smart tools and strategies, you’ll find everything you need to get paid faster and run your business better.
How Accounts Receivable Works?
What is Accounts Receivable?
Accounts receivable is the money your customers owe you. It’s the “IOU” that keeps your cash flow alive. When you sell products or services on credit, the payment doesn’t arrive right away. Instead, it sits in your accounts receivable balance, waiting to be collected. That waiting period can make or break your ability to pay your bills, invest in growth, or even keep the lights on.
Think of accounts receivable as money you’ve earned but haven’t gotten yet. It’s the balance of unpaid invoices owed to your business by your customers. Until those payments roll in, it’s cash you can’t use. AR is listed as a current asset on your balance sheet because it’s expected to turn into cash within a short period, typically 30 or 60 days. Managing it well is the key to keeping your operations running smoothly.
How the Accounts Receivable Process Works
Here’s how it usually goes: You make a sale and agree to let the customer pay later. Once the deal is done, you send them an invoice that clearly states how much they owe and gives them a deadline—often 30 days, depending on your payment terms. Ideally, the customer pays on time, and the process ends there.
It sounds simple, but staying on top of AR takes clear communication, reliable systems, and follow-through when customers don’t pay.
The Core Parts of Accounts Receivable You Need to Know
- Invoices: These tell your customers exactly how much they owe and when they need to pay.
- Credit Terms: Agreements like “pay in 30 days” (Net 30) or “pay in 60 days” (Net 60) that set expectations for payment timing.
- Tracking Payments: A way to monitor who’s paid and who hasn’t, so unpaid invoices don’t slip through the cracks.
Example: Say you’re a distributor. You send $10,000 worth of goods to a retailer and give them 30 days to pay. Until they do, that $10,000 is sitting in your accounts receivable. If they pay late—or not at all—you’re left holding the bag, trying to cover your own bills without that cash.
Most Common Accounts Receivable Challenges
Managing accounts receivable sounds simple—you sell something, send an invoice, and get paid. But it’s rarely that easy.
Late payments are a constant headache. Even good customers miss deadlines, and some delay payments on purpose, leaving you scrambling to cover bills.
Invoicing mistakes, like typos or missing details, can turn a quick payment into weeks of back-and-forth. Fixing these eats up valuable time and energy.
If you’re still using manual systems, keeping track of who owes what can feel impossible. Spreadsheets aren’t built to handle dozens or hundreds of invoices without errors.
Then there are customer disputes. Claims about wrong amounts or incomplete deliveries delay payments even further.
On top of it all, poor visibility into overdue invoices and trends makes it hard to predict cash flow or spot risks early. This is where tools like the cash ratio can help you assess the immediate impact of late payments on your liquidity.
AR management is tougher than it looks, and ignoring these challenges can hurt your cash flow and your business. Fixing them starts with understanding where the problems are.
How to Stay on Top of Your Accounts Receivable
Managing accounts receivable is about having the right systems in place to keep cash flowing and your team focused on bigger priorities. Here’s how you can take control of your AR:
Have Clear Rules for Credit
Before giving customers the option to pay later, make sure you’ve checked their creditworthiness. Stick to simple terms like Net 30 or Net 60. Communicate them upfront. That way you’ll have fewer surprises and less risk of late payments.
Automate Invoicing and Follow-Ups
Manually sending invoices and reminders takes too much time and leads to mistakes. AR software can handle this for you—sending invoices, follow-ups, and even flags for overdue payments. It’s faster, easier, and more reliable
Use AR Aging Reports to Prioritize Follow-Ups
AR aging reports show who owes you money and how late they are. Use them to focus your efforts where they’ll make the biggest impact—like following up on large overdue accounts first. Staying on top of receivables improves cash flow, which is critical for maintaining liquidity and meeting your short-term obligations.
Read: Liquidity and Solvency Ratios – Metrics for Your Business’ Survival
Make It Easy to Pay
Customers are more likely to pay on time if it’s convenient. Accept online payments, credit cards, or bank transfers, and include payment links directly in your invoices.
Get Everyone on the Same Page
When sales, finance, and customer service aren’t aligned, invoices slip through the cracks. Use shared dashboards to give everyone a clear view of receivables and avoid confusion.
Use Tools to Plan Smarter
Integrate your AR system with financial planning tools. This gives you real-time insights into cash flow so you can plan more effectively.
Don’t Waste Time on Small Amounts
Chasing small overdue accounts isn’t worth your team’s energy. Outsource collections for low-priority invoices and focus on the customers that matter most.
Catch Problems Early with Analytics
Predictive analytics can spot which accounts might pay late, so you can act before problems start. Send reminders early or adjust terms for repeat offenders.
Key Accounts Receivable Metrics
Understanding the right metrics is key to improving your accounts receivable process. These numbers highlight where you stand and help you make smarter decisions to keep cash flowing and avoid issues down the road.
Days Sales Outstanding (DSO)
DSO shows how long it takes, on average, to collect payment after making a sale. A low DSO means you’re getting paid quickly, which keeps cash flow steady. A high DSO might signal trouble with collections or credit terms.
Example: If your accounts receivable (AR) balance is $75,000 and your monthly credit sales are $150,000, your DSO calculation for a 30-day period would be:
DSO = (75,000 ÷ 150,000) × 30 = 15 days.
This means it takes your business an average of 15 days to collect payments after a sale.
Collection Effectiveness Index (CEI)
CEI measures how efficient your collections process is. It compares how much you’ve collected to what was due. A high CEI means your collections are running smoothly, while a low CEI shows there’s room to improve.
![Collection Effectiveness Index (CEI) formula = CEI = [(Beginning Receivables + Credit Sales - Ending Receivables) ÷ (Beginning Receivables + Credit Sales - Ending Current Receivables)] × 100](https://www.farseer.com/wp-content/smush-webp/2024/12/cei.png.webp)
Example: If you started with $50,000 in receivables, made $200,000 in credit sales, and ended with $70,000 in receivables, with $20,000 of that over 90 days old:
CEI = [(50,000 + 200,000 – 70,000) ÷ (50,000 + 200,000 – 20,000)] × 100 = 78.26%
This shows that your collections process is 78.26% effective for the period.
Bad Debt Ratio
The bad debt ratio shows the percentage of invoices you don’t expect to collect. A rising ratio is a warning sign—you might need to tighten credit policies or improve payment enforcement.
Example: If you wrote off $5,000 as bad debt and had $500,000 in credit sales:
Bad Debt Ratio = (5,000 ÷ 500,000) × 100 = 1%
Accounts Receivable Turnover Ratio
This metric tells you how often you collect your receivables during a specific time period. A higher turnover ratio means you’re collecting payments efficiently.
Example: If your net credit sales are $1,000,000 and your average AR is $200,000:
AR Turnover Ratio = 1,000,000 ÷ 200,000 = 5
You’re collecting your receivables five times a year.
Keeping an eye on these metrics ensures you’re on top of your accounts receivable process.
Also read:
What the Cash Conversion Cycle Formula Means + Benchmarks & Examples
7 Balance Sheet Ratios for Better Financial Decision-Making
Use Technology to Simplify Accounts Receivable
Technology is changing the game for accounts receivable, turning slow, manual tasks into efficient, automated processes. Here’s how it can simplify your AR management.
Automation for Speed and Accuracy
Manually sending invoices and reminders takes time and leads to mistakes. Automation handles it all—sending invoices on time, flagging overdue accounts, and even automating follow-ups. This reduces DSO and lets your team focus on bigger priorities.
Integrate Accounts Receivable with Your Financial Tools
Linking AR systems with accounting or FP&A tools gives you real-time cash flow insights. There are many tools out there that make it easy to track overdue accounts and payment trends while keeping your financial data in one place.
Predict Problems Before They Start
Predictive analytics helps you spot high-risk accounts and late payments before they happen. Acting early means fewer surprises and better collections.
Conclusion
Managing accounts receivable doesn’t have to be a constant struggle. With the right tools and strategies, you can get paid faster, keep cash flowing, and spend less time chasing invoices. Start by fixing what’s holding you back—whether it’s late payments, manual systems, or unclear processes. Even small changes can make a big difference.
Ready to simplify your AR? Check out how Farseer can help you get started.
