What Are Accounts Receivable Collections: A Complete Guide

Introduction

Ensuring a consistent cash flow is a top priority for CFOs. It’s crucial not only for a business’s survival but also for its growth and stability. Accounts receivable collection is central to this effort. By streamlining how you manage and collect payments, you can ensure a more predictable cash flow and reduce financial risk.

With that in mind, in this blog, we’ll walk you through the accounts receivable collections process, outlining the comprehensive steps and key performance indicators vital for ensuring successful collections procedures.

What Are Accounts Receivable Collections?

Accounts receivable collections involve collecting payments owed to a company by customers for goods or services delivered. This crucial financial process ensures the liquidity and overall financial health of a business, enabling it to meet its operational and financial obligations.

For instance, when a company sells products or services on credit, it creates an account receivable. The collection process involves tracking invoice payments and following up with customers to ensure they pay their bills on time. Thus, in simplest terms, AR collections is the process of managing and collecting payments from customers who owe money to your business.

Why Is the Accounts Receivable Collection Process Important?

Suppose your company has grabbed an excellent sales opportunity and delivered goods and services by agreeing on mutually agreed payment terms, say Net 30. Now, after 30 days of sending an invoice, you are expecting the customer to make the payment. However, what if the payment is not received after the Net 30 period? It can create significant challenges, such as cash flow disruption, risk of bad debt, operational inflexibility, etc.

An efficient payment collection process is essential to minimize these risks. It ensures that you systematically track outstanding invoices, follow up on overdue payments, and manage customer communications effectively. It helps to:

1. Ensure steady cash flow

The collection process is instrumental in improving cash flow by ensuring that funds owed to the company are collected on time. Most companies aim to complete their accounts receivable collections within a 30 to 90-day window, ensuring the timely availability of funds for seamless operations.

2. Facilitate debt payment

Timely collection from customers empowers companies to settle their debts, further bolstering their financial standing. The money, although accounted for, bolsters the operational activity only upon successful collection, underlining the significance of a streamlined collection process.

3. Manage accounting and reporting

Accounts receivable collections are meticulously recorded on the balance sheet, offering a clear picture of the company’s financial health. While an accounts receivable is recorded as an asset, its successful collection symbolizes the actual influx of cash, reinforcing the company’s liquidity position.

4. Foster revenue recognition

The collections process flow contributes substantially to revenue enhancement by ensuring the influx of owed money from existing customers. This process ensures financial growth and stability by minimizing unpaid debts and optimizing cash flow, thereby solidifying the company’s financial foundation.

Key Steps in the Accounts Receivable Collection Process

To ensure that overdue invoices get paid, you need an effective AR collection process. The steps outlined below will help you create one for your business.

Step 1: Aging report creation

The process of AR collections starts right after the invoice is sent to the customers. Businesses should monitor the payment status of each invoice vigilantly. This can be done by generating an aging report to categorize receivables based on their due date, streamlining the collection process, and helping prioritize efforts.

Step 2: Send payment reminders

To ensure that customers do not inadvertently overlook their dues, collection teams must remind them about the outstanding invoices through friendly reminders. These reminders can be courteous reminders a few days before the invoice due date. This serves as a gentle nudge to the customer, helping them prepare to make the payment on time.

Step 3: Begin the dunning process

If, despite the initial reminders, the customer fails to make the payment on the due date, the business can begin the dunning process. Typically, dunning refers to communicating with customers to make them pay for the overdue invoices. This involves sending dunning letters, collection emails, past due notices, and other reminders. With the help of accounts receivable collections automation, businesses can reach out to more customers and reduce time.

Step 4: Do the negotiations

If payment isn’t received after dunning, engage in negotiations. Contact the customer to understand their situation and discuss possible solutions. Offer flexible payment options or revised plans if needed. Document any new agreements clearly and confirm them in writing. Follow up regularly to ensure compliance and address any further issues.

Step 5: Transfer the Account to a collection agency

If negotiations fail to resolve the outstanding payment, involve a debt collection agency. Select a reputable agency experienced in your industry. Provide them with all relevant documentation, including the invoice, prior correspondence, and details of any agreements made. The agency will then take over the collection process, employing their expertise to recover the debt while keeping you informed of their progress.

Moreover, for businesses to recover the debt once an invoice becomes overdue, it’s crucial to have a clear strategy for recovery. They must be aware of the various past-due recovery stages. Let’s understand these stages in detail.

Understanding Past-due Recovery Stages

Effective past-due recovery involves a structured follow-up cadence that ensures you’re not only consistent but also timely in your approach to unpaid invoices.

By categorizing overdue accounts into specific age groups (such as 0-30 days, 31-60 days, 61-90 days, and beyond), you can prioritize your efforts and increase the chances of getting paid.

Each stage of the recovery process has unique milestones, and the key is to act at the right time with the appropriate follow-up actions. Let’s break down a typical model of past-due recovery into stages:

Step 1: Days 1-3 Past Due

Confirm the invoice was sent, ensure no disputes, and send an automated email reminder, including an account statement.

Recognize that customers might be unaware of their overdue status or may require a minor repayment extension. Be flexible and understanding in your approach, viewing your company as a partner offering practical solutions during early-stage collections.

In most scenarios, you will receive a response indicating that your payment is in process or obtain an explanation from your customer. This initial notice also serves as an opportunity to unearth any potential underlying disputes that might be brewing.

Step 2: Days 4-7 Past Due

Contact the customer by phone and/or email, attempting to secure payment. Ensure any discrepancies or disputes have been resolved. Be prepared and specific when you make the phone call, having all necessary invoice details readily available, such as:

1. Copy of the invoice
2. Outstanding balance amount and
3. Invoice number
4. List of unpaid invoices
5. Days past due
6. Due payments amount
7. Payment methods available

Step 3: Days 8-14 Past Due

Send a second automated email and follow up with a professional, scripted phone call. Notify the sales representative that payment is now one week late. Consider offering a payment plan for customers facing financial difficulties, as collecting some debt is better than none.

After your call, make sure you quickly follow up with an email – keeping track of your conversation in writing is key.

Step 4: Days 15-30 Past Due

Send a third automated email stating the account will incur late fees after 30 days. Follow up with a phone call to confirm receipt and remind the customer of late fees. Personalize your past-due notice to increase the chance of getting a response.

Your approach from here on will depend on your existing relationship with the customer. If deemed necessary, send warnings about potential interruptions of service unless the overdue payments are settled.

Be prepared to enforce late fees or halt new orders until the outstanding balance is cleared. These measures, while stern, are about striking a balance – enforcing payment while maintaining the integrity and positivity of the customer relationship.

Your approach should be firm yet respectful, clear yet considerate, ensuring the customer is motivated to settle the dues at the earliest, thereby safeguarding your business’s financial stability.

Step 5: Days 31-45 Past Due

Mail a letter on company letterhead stating payment is now 30 days late. Apply late fees to the account.

Step 6: Days 46-60 Past Due

It’s time to intensify your collection efforts. Begin by consistently calling and emailing the customer every 3-5 business days. Place the account on credit hold and notify the sales representative and customer of the credit hold.

While it’s essential to escalate your efforts and adopt a firmer tone, it’s equally crucial to maintain professionalism and respect in all communications.

It might be frustrating that the payment is significantly delayed despite your multiple friendly reminders, but preserving the customer relationship should remain a priority.

Express your concerns and expectations clearly and respectfully. Make the customer aware that the continued delay in payment is not standard practice and is adversely affecting the business relationship. However, ensure your communication is devoid of hostility or disrespect.

Step 7: Days 61-90 Past Due

When an account reaches 61-90 days past due, it’s time for significant measures. Notify senior management about the delinquent account and prepare to engage a collections agency, seek legal counsel, or write off the account as bad debt. This step is crucial in the collection process steps as it involves higher-level decision-making and external entities.

Be aware of the high cost associated with write-offs. With a 20% gross margin, your business would need to make five times the sales to balance out the loss. This financial strain highlights the importance of exhausting all possible avenues for collection before considering a write-off.

At this juncture, it’s beneficial to involve your sales or account management team actively. Given their direct relationship with the customer, their intervention can potentially unblock the impasse and facilitate payment. Their insights into the customer’s situation and concerns can also inform the next steps in the collection process, ensuring they are tailored to achieve the best possible outcome.

Even in the face of the potential for write-offs, prioritize clear, respectful communication and collaborative problem-solving. This approach not only enhances the likelihood of payment but also preserves the valuable customer relationship for future business interactions.

4 KPIs to Measure Accounts Receivable Collection Goals

Another thing about the AR collection process is that it must be reviewed and updated regularly to ensure that it keeps performing well for the business. Here are 4 key metrics that businesses must monitor to assess their AR collection process:

• Days Sales Outstanding (DSO):

What is it? DSO calculates the average number of days it takes to collect payment after a sale has been made.

Why is it Important? A lower DSO indicates a shorter collection time, improving cash flow.

• Collection Effectiveness Index (CEI):

What is it? CEI assesses the ability to collect accounts receivable.

Why is it Important? A higher CEI indicates more effective collections.

• Aging Accounts Receivable:

What is it? This report categorizes receivables based on how long they have been outstanding.

Why is it Important? It helps prioritize collection efforts, focusing on older, higher-risk accounts.

•  Percentage of Accounts Over 90 Days:

What is it? It calculates the percentage of receivables outstanding for over 90 days.

Why is it Important? Reducing this percentage lowers the risk of bad debt.

In a Nutshell:

Efficiently measuring your accounts receivable collection goals is not just about numbers. It’s about ensuring your collection strategies are on point, enhancing your cash flow, and fortifying your financial health. Stay consistent with monitoring these metrics, and this will help you stay on the path to sustained growth and profitability.

5 Challenges in Traditional Accounts Receivable Collections

Maintaining efficiency and accuracy in accounts receivable collections is crucial for businesses. However, with traditional collection procedures, collections teams encounter several significant challenges that can hinder their performance and effectiveness. These challenges include:

1. No clear account prioritization – the reactive response

In the traditional collection process, actions are typically reactionary, triggered by late payments. This reactive stance makes it tough for businesses to effectively prioritize customers.

Limited visibility into at-risk accounts further complicates the situation, preventing the implementation of targeted, effective collection strategies. The abrupt shift from friendly to aggressive communication can also damage customer relationships, making the collection process even more challenging.

2. Lack of personalization in dunning

Traditional collection processes often take a generic approach to dunning. This lack of personalization fails to account for each customer’s unique circumstances and preferences, leading to increased frustration and reducing the chances of successful debt recovery.

Understanding each customer’s situation and taking a tailored approach is crucial for maintaining positive relationships and enhancing collection efficiency.

3. Manual collections outreach process

Nearly half of the firms identify manual processes as a significant bottleneck in their AR management. Manual collections outreach, characterized by disjointed communications and follow-ups, leads to inefficiencies and delays in the collection process.

Firms using manual processes take 67% longer to collect payments than those employing automated tools, impacting the business’s overall cash flow and financial health.

4. Absence of a centralized view of customer data

Insufficient backup documentation and information often hampered collection and dispute management. Without a centralized view of customer data, resolving disputes becomes a prolonged, cumbersome process, further straining customer relationships and delaying collections.

5. High cost of customer loss

The latter stages of the traditional collection process, particularly after 60 days of non-payment, often lead to customer loss. This loss goes beyond a one-time revenue hit, impacting long-term revenue with the loss of potentially loyal customers.

It underscores the essential need for a more nuanced, customer-centric collection approach to retain valuable customer relationships.

5 Strategies to Improve Your Accounts Receivable Collections

Now that you know the challenges involved in the accounts receivable collections process – let’s discuss the strategies to handle it well.

1. Be systematic

All unpaid invoices must be followed up with payment reminders. Implementing systematization, like automatic dunning, will solve the majority of AR problems.

Most customers will pay; they just need a reminder. This approach will also help you identify and focus on problematic customers who ignore automated dunning, saving you time and effort.

Ensure that reminders follow a clearly defined timeline to identify and address technical and commercial issues promptly. Create a systematic escalation process with proactive steps to resolve or address issues faster.

2. Personalize your approach

Efficient reminders consider your customer’s business context. Avoid impersonal, inaccurate, automated emails that do not reflect your business relationship with the customer.

Personalize your reminders to improve your response rate and resolve underlying issues with late payments faster. Understanding the root cause of late payments, and considering different geographic locations, payment methods, etc., will make your reminders more impactful.

3. Utilize multi-channel communication

Each communication channel (email, calls, texts, and sometimes letters) should serve a specific purpose in your cash collection process. Ensure they involve the right people on both ends of the conversation. Diversify your communication channels to make the cash collection process more impactful and to correctly gauge the level of urgency and obtain feedback from your customers.

4. Be quantifiable and data-driven

Set clear objectives to guide your teams in the cash collection processes. Start by targeting to reduce the total amount of overdue invoices. For a more long-term, sustainable approach, focus on reducing the average payment delay or Days Sales Outstanding (DSO). Communicate internally on these quantifiable metrics and objectives to align your team around cash collection.

5. Choose the right automation tools

The right tool is key in translating your AR strategies into a real process. While your accounting software or ERP might be a starting point, many companies still use spreadsheets to manage accounts receivable, making implementing an efficient collection process difficult.

With the help of the right collection automation software, businesses can enhance their collection efficiency by reducing manual work. Equipped with advanced technologies like Artificial Intelligence and Machine Learning, these tools streamline processes, predict payment behaviors, and provide actionable insights, leading to more effective and efficient collections.

Optimize Your Collections Process with HighRadius’ Collection Software

HighRadius’ AI-based collection automation software is designed to help businesses eliminate the hassle of managing the accounts receivable collections process. With out-of-the-box automation capabilities, the software accelerates the process of collecting past dues from customers.

Here’s how our solutions help you establish a streamlined and personalized collections process that saves your team time:

• It offers the advantage of an AI-prioritized worklist that determines which customers should be contacted and what action should be taken.
• It accelerates the process of calling and following up with your customers with an in-app dialer, which makes calling faster and simpler.
• With an intelligent email inbox, it enables you to obtain a centralized view of all incoming and outgoing collections emails.
• It automates the time-consuming task of creating and managing email templates for correspondence and sending emails with advanced dunning capabilities.
• Auto-draft email, generate reports and call summaries with Generative AI via FreedsGPT.
• Upload invoices, track invoice payment statuses, and log disputes with AP portal automation, which leverages RPA to log into AP portals.

FAQs

1). What is a proactive collection approach?

Proactive collection is a strategic approach in accounts receivable collection where businesses initiate contact with customers before the invoice due date. This helps organizations ensure payments are made on time, addresses any issues early, and keeps cash flow healthy.

2). How do you record the collection of accounts receivable?

To record the collection of accounts receivable, debit the Cash account and credit the Accounts Receivable account in your ledger. This entry reflects the receipt of cash from a customer to settle an invoice. Keeping these records accurate helps companies track their cash flow efficiently.

3). What happens to uncollectible accounts receivable?

Uncollectible accounts receivable, also known as bad debts, are written off as an expense in the income statement. This means they are removed from the accounts receivable balance because they are unlikely to be collected, helping to maintain accurate financial records.

4). What is the AR collection ratio?

The Accounts Receivable Collection Ratio measures the effectiveness of a company’s debt collection efforts over a specific period. It is calculated by dividing the net credit sales by the average accounts receivable, helping businesses assess their credit and collection efficiency.