What is accounts receivable and where can it go wrong?

What is accounts receivable (or trade debtors)?

Accounts receivable is the money owed to your business by customers, and the process of collecting it. When you send an invoice (or bill), it becomes part of your accounts receivable – until it’s paid.

The accounts receivable process includes:

• Sending invoices
• Tracking payments
• Following up on overdue payments
• Matching payments to invoices (also known as invoice reconciliation)

The accounts receivable process is sometimes called bills receivable, and some people simply call it invoicing. Learn how to build a watertight accounts receivable process.

What is ageing of accounts receivable?

If an invoice hasn’t been paid by its due date, you start to age it. You do this simply by counting each day that’s passed since it was due. If it was due four days ago, you give it an age of 4 days.

What does an ageing report do?

An ageing report shows all the past-due invoices, from least overdue to most overdue. At a glance, you can see which bills you’re waiting on, and which have been outstanding the longest.

The more an invoice ages, the less likely it is to get paid at all, so review an updated report often and act decisively. Decide what steps you’ll take to recover debts as they age:

• Will you email at day 1?
• Will you call at day 3?
• What’s your next move?
• And when will you make it?

Get tips from our guide on how to treat overdue invoices.

Is accounts receivable an asset?

Yes, accounts receivable is money you’re owed, which makes it an asset. In fact your invoices are so valuable that some companies will even buy them off you.

Once an invoice is paid, it’s no longer an asset – it becomes cash in the bank, which is even better. And if you never get paid, you’ll ultimately write off the invoice as a bad debt. Once it’s written off it’s no longer considered an asset.

Can I sell my invoices?

Yes, invoices are money owed to your business. If you sign them over to someone else, they can collect the money.

Through accounts receivable financing, finance companies will buy invoices from businesses that can’t wait for the customer to pay, providing immediate cash.

These finance companies realise that older invoices are less likely to get paid. So you probably won’t find anyone willing to buy really old invoices.

What is accounts receivable financing?

Accounts receivable financing, also known as invoice financing or invoice factoring, is a way to access cash tied up in unpaid invoices.

Here's how it works:

1. Some finance companies will pay you up to 90% of an invoice's value upfront. (It’s a way to get money you’re owed without waiting on a customer to pay)
2. Once the customer pays the invoice, the company sends you the second (remainder) payment, minus fees.

You’ll never get the full value of the invoice, because the finance company takes fees. And they won’t buy old invoices so it’s not a dumping ground for bad debts.

Speak to your accountant or financial advisor before using these types of services.

What is a bad debt?

When invoices aren’t likely to be paid, you should write them off as a bad debt.

It’s lost income, and it’s important to capture that in your accounting records – especially as you may have already paid tax on that invoice. And seeing as the income isn’t going to happen, you need to claim that tax back. You do this by writing off the invoice.

When should I write off a bad debt?

You should write off a bad debt whenever you think there’s no reasonable chance of getting paid, such as when:

• The customer has gone bankrupt
• There is an unresolved dispute that’s unlikely to be settled
• Payment reminders are being ignored

Whether you write it off after 6 months or 18, don’t give up on it. Even after you’ve written off the debt, keep sending invoice reminders. If they finally pay, you can always declare the income on your next tax return.

Now you know what accounts receivable is, what should you do about it?

When everyone’s late paying, business gets hard. You might run out of money to pay suppliers or staff. It’s one of the most common reasons businesses go broke.

It’s important to treat invoices like the assets they are. Set up an accounts receivable process that maximises your chance of getting on-time payment. There’s a lot you can do.

Learn more about how you can work smarter with Xero’s intuitive invoicing software.