Best Practices For Managing Account Receivables And Payables

Tahir Lahai

Associate

It is no secret that many businesses, especially large ones handling high volumes of transactions, struggle with effective cash flow management. This often makes it challenging to manage accounts receivable (AR) and accounts payable (AP). Maintaining healthy cash flow and ensuring financial stability requires efficient management of both. Proper handling of AR ensures that businesses receive timely payments from customers, while managing AP helps ensure that bills are paid on time, preventing cash shortages and avoiding penalties. Managing these accounts is a complex balancing act, but it is crucial for accurate tracking of purchases and for avoiding the risk of overpaying or missing payments for goods and services—a situation no business wants to face!

WHAT IS ACCOUNT RECEIVABLE AND PAYABLE?

While you may already know the basics of AR and AP, it is important to have a clear understanding of what they mean and how they function.

ACCOUNT RECEIVABLE (AR)
AR refers to the money owed by customers to a business, usually in the form of unpaid invoices. Essentially, it means the business has earned the money by delivering products or services but has not yet received payment at the time of the transaction. AR is considered a line of credit extended by businesses, with terms requiring payment within a specific period, typically 30, 60, 90 days, or in some cases, up to a year. Businesses record AR as an asset on the balance sheet, as customers are obligated to pay, and the business is expected to collect the owed amount.

ACCOUNT PAYABLE (AP)
AP is the opposite of AR. It represents short-term payments owed by a business to its vendors or suppliers for goods or services received on credit. Like AR, AP is a key figure on the balance sheet. An increase in AP signals that a business is buying more goods or services on credit rather than paying upfront, while a decrease means previous obligations are being paid off faster than new items are being bought on credit.

These concepts underscore the importance of effectively managing both AR and AP to maintain financial health.

HOW TO MANAGE ACCOUNT RECEIVABLE AND PAYABLE

Businesses that effectively manage AR and AP tend to experience smoother cash flow and fewer cash management concerns. Here are some key strategies for improving AR and AP management:

1. ESTABLISH STRONG CREDIT POLICIES
Most business owners and managers want transactions to close quickly. The AR department typically sets credit terms based on the client’s history. Long-term customers with good credit ratings should be given more flexible payment terms, while first-time customers may not receive the same leniency. Conducting credit checks on new clients before extending credit helps avoid bad debts. Generally, businesses set payment terms between 15 and 30 days. On the AP side, businesses should pay suppliers promptly once goods are received in good condition. Timely payments may also allow businesses to take advantage of early payment discounts.

2. SHORTEN TRANSACTION CYCLE
Reducing the transaction cycle for buying and selling goods or services can lower labour costs. Long cycles can indicate workflow inefficiencies or cash flow issues, such as waiting for customer payments before paying suppliers. To avoid this, establish clear timelines for managing both receivables and payables. Aim for shorter receivables timelines to handle payables more effectively. Encourage departments to follow routines by issuing invoices, purchase orders, and other documents on specific days to create a consistent workflow.

3. IMPROVE COMMUNICATION BETWEEN DEPARTMENTS
Managing AR and AP can be challenging, especially with many transactions. To simplify things, both departments should coordinate on purchases and sales that affect the business. For example, if customer demand is high, AR can inform AP to increase orders. Conversely, during tight financial periods, AP may need to reduce procurement until conditions improve.

4. STAY ONTOP OF AGEING ACCOUNTS
It is vital that all transactions are recorded promptly, and statements are sent regularly. Reviewing older accounts to ensure everything is settled is equally important. If any receivables are overdue, take immediate action and halt further business with the client until their account is cleared. Implement policies that set a maximum time limit for customers to settle their accounts. Similarly, for AP, if supplier payments are overdue, make those payments as soon as possible and set timelines for clearing outstanding payables.

CONCLUSION
Effectively managing accounts receivable and payable is crucial for assessing the financial health of a business. Keeping accurate track of these accounts provides insight into overall business performance and also helps managers and owners make informed decisions that shape the business’s future. By establishing strong credit policies, shortening transaction cycles, and improving communication between departments, businesses can maintain liquidity, minimize financial risk, and achieve sustainable operations.