What Is Accounts Receivable and How To Manage It

Key takeaways

• Track every unpaid customer invoice so you always know what cash is coming in and when.
• Follow a clear AR process, from credit approval and invoicing through collections, to get paid on time.
• Measure AR turnover and days sales outstanding to spot slow-paying customers before cash flow tightens.
• Automate invoicing, reminders, and payments with a tool like Melio to save time and cut errors.

What is accounts receivable?

Accounts receivable (AR) is the money customers owe your business for goods or services you have delivered but not yet been paid for. It appears on your balance sheet as a current asset.

Accounts receivable is any payment you expect for goods or services already delivered. For example, an electrician bills a customer $7,500 for lighting work. Until that invoice is paid, the $7,500 is accounts receivable.

Although AR refers to money that hasn’t yet been paid and is still outstanding, it’s listed on the balance sheet under assets as current assets. Any amount owed by customers for purchases made on credit is also considered AR.

Why is accounts receivable important?

Every business aims for profitability, and being profitable means getting paid for the work that you do. No business will thrive if it can’t keep track of customer bills and payments.

Especially for small and medium-sized businesses who may be DIY-ing their accounting and bookkeeping, here are several reasons why AR is so important:

• Cash flow: AR helps you track how much revenue is expected to come in and when. This knowledge is essential to plan for day-to-day operational costs and invest wisely in business growth. For example, the electrician wants to buy an expensive tool that could open up a new avenue of business. But looking at his AR, he doesn’t have a lot of cash expected to come in next quarter. So it’s best to wait a few months to reassess the purchase.
• Customer relationships: Smart AR management helps you plan your income stream and offer credit terms that will be attractive to potential customers. A smooth accounts receivable process also means you can gently remind customers when payments are close to their due date, avoiding potential unpleasantness or conflict.
• Credit management: Tracking accounts receivable allows businesses to assess the creditworthiness of their customers. This way, you can minimize the risk of non-payment and prevent financial losses.
• Liquidity and business growth: AR helps you track and improve the business’s liquidity, so you can more easily secure loans and funding to help your business grow. It also lets you extend credit to customers with efficiency and peace of mind, so you can increase sales volume and market reach.

How does the accounts receivable process work?

The accounts receivable process turns a customer order into collected cash. Most businesses follow these steps:

Step 1: Purchase order

The AR process starts when a customer places an order for goods or services. Often, they will provide a purchase order (PO), which outlines the details of the future transaction, including items ordered and the agreed price.

Step 2: Sales order

Once the PO is received and approved, the business owner or accounting team issues a sales order (SO). The SO confirms the sale, the goods or services purchased, the payment amount, the expected delivery date, and other terms and conditions of the sale.

Step 3: Credit given

The SO is reviewed and approved on credit issued to the customer. The details of the credit are recorded in the account books with the business as the creditor and the customer as the debtor.

Step 4: Invoice issued

Once the goods or services have been provided, the invoice is issued to the customer. In some cases, the business requests an advance or partial payment upfront. Then the final invoice after the sale is completed will cover the unpaid portion of the original amount. Either way, invoices must include all payment details, including goods or services provided, payment amount, due date, and the reference number for the purchase order.

Step 5: Collections

The AR team or business owner now collects payments from outstanding invoices. Payments can be received via cash, check, bank transfer, or credit card. Businesses should make it as easy as possible for customers to pay. Some online AR platforms, like Melio, let businesses choose how to pay digitally, including bank transfer or credit card, while you receive the funds however you prefer.

Tracking AR helps you see which payments are getting close to their due date, or are overdue. Then it’s time to launch into overdue collection processes, whether that’s reminder emails or issuing late payment fees.

Once the invoice is settled, the amount is deducted from accounts receivable and recorded in the balance sheet as an increase in cash or bank balance.

How to measure accounts receivable health (turnover and DSO)

Two simple measures tell you how well your business collects what it is owed.

The accounts receivable turnover ratio shows how many times you collect your average receivables over a period. A higher number means you turn invoices into cash quickly.

Days sales outstanding, or DSO, shows the average number of days it takes to get paid after a sale. A lower DSO means faster collections and healthier cash flow.

Tracking these numbers over time helps you spot slow-paying customers early. You can then adjust your credit terms before cash flow tightens.

Accounts receivable vs. accounts payable: what’s the difference?

Accounts receivable and accounts payable are two sides of the same coin.

AR is the money your business is owed by customers for goods or services you have already provided, while accounts payable (AP) is everything your business owes for goods or services already provided to you.

That includes all your business expenses such as rent, taxes, utility bills, supplies, and vendor payments.

The difference is direction: AR is money coming in, AP is money going out. Accounts receivable sits under current assets. Accounts payable sits under current liabilities.

Let’s take a look at accounts receivable vs. accounts payable, side by side:

How to manage and improve your AR process

A strong AR process protects cash flow by getting invoices paid on time and cutting manual errors. One of the best ways to keep it running well is to automate it.

Let’s say, for example, you run an organic farm, selling quality vegetables to restaurants across the state. You make a sale and deliver the produce yourself, provide an invoice, and receive a check as payment. But one of the checks you received bounced. Not only that, but you forgot to update your books with the correct amount, and the customer now claims the amount was lower than what you agreed upon.

Human error is entirely predictable and common, especially in accounting and finance. No matter how much you trust your customers, using an online platform to automate and manage the accounts receivable process will help prevent difficult circumstances like these. If problems do arise, having an accounting tool at your back will make it much easier to resolve with minimal conflict.

There are different tools that allow you to manage all your AR online. Melio, for example, makes it easy to keep track of all your customer invoices, request payments, and receive payments online. Melio eases the AR process from A to Z, by tracking and recording all invoice details for all customers. By connecting your bank account, you get paid directly to your bank account, reducing check handling time and costs.

Let’s take a look at some extra benefits of digitizing your AR process with a tool like Melio:

Automate your accounts receivable process

In this article, we’ve covered the essentials of accounts receivable—what AR is, how an efficient accounts receivable process contributes to your business’s financial health, and how digital payment platforms can benefit this process.

Now it’s up to you to implement an online AR process that will improve how you collect outstanding payments, and ensure all the money you are owed actually comes in, on time.

Accounts receivable FAQs