Introduction
One of the most important aspects of financial functions in any business that sells goods or services on credit is known as Accounts Receivable (AR). It’s an amount of money that the customer is owing after they’ve received a product or service, but haven’t yet paid for it. Good accounts receivable record keeping allows businesses to keep track of outstanding accounts, anticipate cash receipts, follow up on the account, and create accurate financial statements. But, mistakes can cause serious financial issues in the AR process. These errors include not invoicing an opportunity, improperly applying payments to the wrong products or services, not recognizing bad debts, and overstating revenue, which can lead to the delayed collection of payment, incorrect customer balances, poor cash flow and misleading financial statements. Such errors could also lead to customer dissatisfaction or even negatively impact the relationship with the customers, as they may lose trust in the business if they receive an invoice or payment reminder that is inaccurate. A good accounts-receivable method increases cash flow and ensures that the accounts-receivable and revenue amounts reported reflect the company’s financial status.
Accurate Accounts Receivable Management is Crucial for Several Reasons.
Managing accounts receivables involves more than just making an invoice and getting paid. It can have a direct effect on a company’s cash flow, working capital, profitability reports and meeting financial obligations. Even if a business has a lot of sales on its books, it may not be profitable if customers are not paying on time, as the business may be having trouble paying bills, rent, employees, etc. By having accurate AR records, a business owner and the finances team can determine which invoices are uncollected, how many balances are overdue and who they might need to follow up with. Accurate records also help in better forecasting as management will be able to calculate the expected cash payments and when they will occur. In cases where AR information is incomplete or inaccurate, business decisions might be made on the basis of wrong assumptions. As a result, businesses should view AR not as a financial process, but one that’s strictly controlled, well documented, reviewed regularly, has clear responsibilities and communicated with customers in a timely fashion.
1. Invoices are not Recorded.
One of the worst A/R errors is the failure to update invoices once goods/services have been delivered. This mistake can happen if an employee mistakenly forgets to make an invoice, if they do not enter it in the accounting system in time, if they lose the supporting documents or if they think that another employee has already done it. If an invoice is not recorded there is a possibility that the customer will never be issued a formal request for payment. This means that time is wasted in the business and it could be delayed in recovering money it has already earned. Additionally, the error may result in the understatement of the accounts receivable balance and revenue during the reporting period in which the error occurred. If the invoice is found at a later date, the business may have to go back and correct other items making the financial reporting/reconciliation tasks more difficult. Sometimes, the customer might contest the late invoice as the information is not fresh or there may be lack of supporting evidence.
Undocumented invoices also may make it hard to assess the success of the sales and collections jobs. There may be some outstanding balances which are not reflected in the records and hence the management may think that sales were lower than expected or customers are paying faster than they actually are. This leaves a false impression of the company’s financial condition, which can result in wrong financial decisions. A straightforward invoicing process can help minimize this risk when it starts as soon as a sale is made or a service is provided. All sales records, delivery confirmations, contracts and work-completion documents must be matched prior to the issuance of an invoice. Some accounting software also has the ability to automatically create an invoice based on an approved sales order, or a job that’s completed. Having regular checks of the sales register in relation to the invoice register can help ensure that the transactions are not lost prior to the situation becoming a major issue for reporting or collections.
Ways to Avoid Missing an Invoice.
Consistency, accountability and an effective internal control system are essential for preventing the loss of invoices. The credit sale process should be written and delineate who is responsible for creating the invoice, who is responsible for it being reviewed and when it needs to be sent to the customer. It is important for businesses to not just use informal communication, handwritten notes and only just remember it, as this can increase the likelihood that the transaction will be missed. The daily/weekly invoice register can assist AR staff to ensure that all sales are invoiced. Important information to be included in the register should include the customer’s name, invoice number, invoice date, amount, payment terms, due date, etc. Management should also make sure that the invoices are matched with sales order, shipping, service reports or other documentation of transactions. These checks provide an audit trail and help to identify gaps. As soon as businesses record the invoices quickly and accurately, they can start the collection process earlier, have better cash flow and have better and more reliable receivable and revenue records.
2. Misapplying Customer Payments
Misapplying customer payments is when you receive payment from a customer and post it to the wrong customer account, invoice, for the wrong amount or leave it unapplied in the accounting system. This is a common error that customers make when they pay multiple invoices at the same time, pay on references that aren’t clear, make partial payments, or pay by different methods. Another common issue with manually entered invoices is that an AR clerk can make a mistake in the invoice number or customer information. However, the business may have accepted the funds but the accounting records may still indicate the right invoice is late. This may lead to the sending of unnecessary collection e-mails, reminders, or phone calls to customers who have paid for the service. These mistakes can lead to customer dissatisfaction and a lack of trust in the organization, as it seems disorganized and cannot accept legitimate transactions. Training can also cause problems if payments are made incorrectly, which may lead to inconsistencies in customer account statements, and slow down the time needed to reconcile the amount of money that is owed.
The impact of incorrect payments can be not just a source of frustration for customers, but also adversely impact finances. If the payments are posted incorrectly, AR aging reports can appear to show the overdue amount even though it isn’t. Management could then think that collection is not good or that some customers pose a greater risk than is actually the case. Staff may spend time chasing payments which have already been made rather than on the true overdue payments. Also, if the payment is applied to the wrong invoice, the outstanding balances could be hidden by the incorrect applications. Businesses must have employee’s double check the names, payment amount, invoice number, and date of transaction before posting receipts. If the payment details are not clearly known, the money should be deposited to a temporary, unapplied cash account (T A), which will be claimed when an appropriate invoice is provided. This is a better way than guessing and making more mistakes on the customer’s books.
Easing the Accuracy of Payment Application
To ensure the accuracy of the payment application, businesses could try to encourage customers to pay using their invoice number or unique reference number. This should be clearly stated on all the invoices and outline the methods of payment accepted and what details customers are required to need to provide. Payment remittance should be checked and compared to bank deposits prior to updating customer accounts by AR staff. If possible, accounting software should be connected to the banking system or payment application, thus avoiding the repetitive manual bookkeeping. While automation is a great tool, it should not be used to replace review as there can be some missing references or matching errors in imported transactions. Policies for reconciling bank statement with cash receipts, customer accounts and general ledger regularly can detect unapplied payments and/or payments posted incorrectly. Revising customer statements monthly will also help as the customers might see something that you haven’t seen. Making the payment application accurately helps companies keep up trustworthy client balances and center collection endeavors on those that genuinely owe.
3. Ignoring or Delaying the Write-Off of Bad Debts
Another inconsistent note taking with A/R that can mislead financial reports is to not write off bad debt. Bad debt would be the debt that the business no longer reasonably expects to be paid. This can occur when a customer may become insolvent, permanently close the business, refuse to pay a debt that can’t be settled, or just fail to pay after and after collection efforts have been made. It can be tempting for some businesses to not write them off, because otherwise profits will seem smaller, or it may imply that there’s been a lack of credit management. But the presence of clearly uncollectible amounts in the accounts receivable position can overstate the value of the assets, and provide a false sense of expected future cash flows. It can also make AR aged reports look worse by simply continuing to accrue old balances regardless of whether there is a realistic chance the balances will be paid.
There isn’t always a quick-fix method for overdue money owed, but an appropriate bad-debt plan does not imply that companies must immediately write off all overdue invoices. Rather, management should set forth guidelines on when collection is likely no longer to be possible. These criteria could involve, but are not limited to, age of debt, customer’s financial condition, failed collections, legal counsel, and proof that the customer ceased business. The business should note the reasons for the balance being written off and seek the necessary approval prior to the balance being written off. The accounting treatment should be in line with the accounting policies of the company and the financial reporting requirements. For many businesses, credit losses are estimated or an allowance for doubtful accounts is kept, in order to account for losses before accounts are actually written off. This results in more accurate financial statements, and helps to avoid significant one-off adjustments. Analyzing the doubtful and uncollectible accounts regularly allows businesses to maintain accurate records of their receivables, and also helps them avoid posting the amounts as collectible if there are no reasonable grounds to believe they will be paid.
4. Overstating Revenue through Accounts Receivable Errors
Revenue should be the income that the business has actually received as a result of the transaction in accordance with the relevant accounting principles and the terms of the transaction. But, when the invoices are created prior to delivery of goods or services, or without adequate supporting evidence that the business has earned the revenue, accounts receivable errors can cause overstated revenue. Revenue can also be over-stated if there are duplicate invoices entered, cancelled transactions recorded in the accounting system or if estimated amounts are recorded as sales. Those errors can lead to a company’s financial indicators to suggest that it is more profitable and successful than it actually is. A lack of accuracy in revenue reporting can impact investors, lenders, managers, tax authorities and other stakeholders, as it will influence their decision making. Therefore, revenue is only to be recorded if the transaction is a legitimate transaction, if documented, and if the revenue is “recognized” in the appropriate accounting period.
Inflated revenues can result in a domino effect in the financial statements. If revenues are booked wrong, accounts receivable might also be overstated since the business is claiming a balance owed by a customer that may not be legally and/or commercially collectible. Profit figures can be manipulated which can impact business valuations, borrowing plans, tax calculations, bonuses and performance evaluation. If the error is found after the issuance of financial statements, then the company may have to revise previous statements and provide an explanation to shareholders of the big difference. If the revenue is intentionally over-inflated, this can be considered as financial statement manipulation or fraud. This risk can be mitigated by having the approval of sales, accounting for the invoice, recognition of revenue and financial reporting separated within a business. Before revenue is recognized any supporting documents, including signed contracts, delivery confirmations, customer acceptance documents and service completion documents should be consulted. The controls are strong and they help to ensure that reported revenues are consistent with the transactions in the business, not based on assumptions, do not include any duplicate entries and/or do not reflect revenues that have been recognized prematurely.
5. Failing to Review Accounts Receivable Aging Reports
An accounts receivable aging report is a report that categorizes the money that is still due from customers based on the length of time the money is overdue. Common categories could be current, 1-30 days past due, 31-60 days past due, 61-90 days past due, and 91-120 days past due, etc. This report can be left unchecked for a long time and overdue accounts may not be noticed until it is too late to collect. The longer an invoice is outstanding, the higher the likelihood that a customer won’t be able to pay, may argue that it wasn’t theirs, or don’t want to pay. Additionally, AR personnel may not be able to detect consistent payment issues or customers who routinely default on payment deadlines if there are no regular reviews and monitoring. This affects the collection performance and cash flow is less predictable. Re-check aging information at least on a monthly basis, and, for organizations with a heavy volume of credit transactions, perhaps once a week.
The most useful thing about aging reports is if the business makes use of the information contained within them. The AR staff should be focused on top accounts by the amount due, longest delay, customer payment history, and collection risk. Remind customers with recently overdue balances and contact those with older balances, make a formal demand, offer a payment plan or refer to management. It is also advisable to check the report for unusual credit balances, duplicate invoices, unapplied payments, and/or disputed transactions as it may be a sign of accounting issues and not necessarily a collection issue. The proportions of overdue receivables as well as the average collection period should be tracked by management. Regularly checking the accounts gives businesses the time to take action against bad debts quickly, to avoid them and to keep their cash flowing.
6. The Poor Communication regarding Invoices and Payment Terms.
Sometimes, even the right invoices can get paid late when customers are not sure of their payment terms or businesses don’t communicate effectively. Not all invoices contain a readily apparent due date, payment terms accepted, bank information, contact information, or detailed information regarding the goods/services rendered. If there is a variation between the quotation and the invoice, and the supporting documents are lacking, the customer may take a while before paying for the invoice. One other error that businesses can make is that they send an invoice to the wrong name for their customer or the wrong email address. These communication problems cause unnecessary delays and more time for AR personnel to waste on answering questions. Comprehensive and accurate invoices enable customers to easily understand their liability and minimize dispute. They also ensure their professionalism and they remind customers of the payment deadlines.
Confirm customer billing details prior to issuing invoices, and make changes to customer contact details when changes happen. Payment terms should be discussed with the client prior to the sale and should be included on the invoice. For instance, the billing terms should be indicated as instant, 15 days, 30 days or any other arrangement that has been agreed upon. In addition, it is a good practice for businesses to remind customers before and after a deadline to pay, while an account is not really overdue. Automated reminders are a great way to be more consistent, but messages should be checked to make sure that customers aren’t getting reminders for paid or disputed invoices. Clear and orderly communication can minimize misunderstandings, expedite payment and maintain a good relationship with customers, and help ensure accurate accounts receivable tracking.
Establishing a Better Accounts Receivable process
A good accounts-receivable procedure should encompass all aspects of the credit-sales process from the time a credit sale is approved until the customer pays, it is recorded and reconciled. Businesses need to have policies and procedures in writing that cover customer credit checks, creating the invoices, payment terms, payment application, follow-up on outstanding payments, handling disputes and bad debt reviews. Staff should have an awareness of the roles and be trained in the proper use of accounting systems. Ideally, important work should be broken up between staff or people to avoid one member of staff controlling all aspects of the transaction from issuing the invoice to recording the payment. Management should also check AR reports frequently and do some investigation into any unusual balances that may exist, old invoices, big adjustments and changes in collection performance. They need not be so complicated, but they should be regular in nature and suitable to the size and risk of the business.
Technology can be used to facilitate this better AR process, through automating the creation of invoices, sending out payment reminders, matching receipts, keeping track of overdue amounts, and generating reports in real time. But, technology doesn’t work if the information that is fed into the technology is wrong. Companies should have processes in place to quickly review automated transactions and correct for errors. It is important to have periodic reconciliations between the accounts receivable subsidiary ledger, customer statements, bank records, and the general ledger. These are reconciling statements to ensure that there is consistency between recorded invoices, payments and outstanding balances in the accounting system. It is also important for companies to track the quality of collections over time and apply the findings to fine-tune credit policies and customer follows up. A structured process minimizes delays, enhances cash flow, and enables management to have reliable information to plan and make decisions.
Conclusion
AP errors can cause issues with customer accounts and lead to larger financial issues. Not tracking invoices could result in payments not being collected, and incorrect or improper application of payments could lead to wrong balances and affect customer trust. Bad debts may be overstated as a result of not being recorded or being recorded in a timely and accurate manner; and if revenue is recorded too soon or incorrectly, profitability reports will be misleading. Other issues such as not checking aging reports and not communicating well on payment issues can lead to additional delays in collections and losses. These issues can be avoided by implementing AR procedures that are clearly defined, keeping good records, regularly assessing customer accounts, reconciling accounting records, and having sound internal controls. Acceleration of payment, accurate and truthful accounts of receivable and revenue reporting, cash flow protection and better customer relations are all benefits of the improved accuracy of invoicing and collection procedures for business owners and AR clerks.
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