If you're running a business, you already know how important your accounts receivable are. After all, they represent the money that's owed to you by your customers. But when it comes to managing accounts receivable, understanding what a debit or credit means can be confusing.
This article clarifies that confusion, breaking down how receivables work in a business's accounting system. By the end, you'll understand how to handle accounts receivable so that your business is well-organised and financially healthy.
What are accounts receivable?
Your accounts receivable are the money people owe to your business. These can include customers who have placed an order and are awaiting payment or those with existing invoices that haven't yet been paid.
Think of them as essentially a record of all the debts owed to you by people outside of your company.
Since accounts receivable covers the money currently owed to your business and significantly impact your cash flow, keeping track of them is essential.
Accurate record-keeping of your accounts receivable also helps you track which customers are slow to pay and lets you politely remind them if necessary.
What is the difference between a debit and a credit?
Foundational concepts in accounting, a debit and a credit are two types of entries that you record in the accounts receivable ledger. Though they’re opposites of each other, it's important to understand their differences and how they impact your business.
Debits refer to an increase or addition of assets or expenses, while credits refer to a decrease or subtraction of liabilities, assets, or income.
In other words, a debit is an entry on the left side of your accounting ledger, and a credit is on the right.
As you make entries in your accounts receivable ledger, it's important to remember that a debit always increases an asset or expense account while a credit decreases them.
It's also important to note that debits and credits affect different types of accounts differently. For example, revenue accounts will increase when a credit is applied, while an asset account increases with a debit entry.
Cash and inventory accounts are the only two types of accounts that increase and decrease with debits and credits, respectively.
Are accounts receivable debit or credit?
When it comes to determining whether your accounts receivable are a debit or credit, the answer is both, which can get confusing.
When a customer places an order, the accounts receivable account is credited on the right side of your ledger. This indicates that money will soon enter your business as payment for goods or services rendered.
However, when you receive the payment from the customer, it will then be debited to the account receivable column on the left side of your ledger. This indicates that money is entering the business to pay off a debt.
So, as you can see, accounts receivable are both debit and credit entries in your accounting ledger since they involve two different types of transactions.
How to apply a debit or credit to accounts receivable
Applying a debit or credit to your accounts receivable is a simple process. For debits, simply add the amount to the left side of the ledger (the debit column).
For credits, subtract the amount from the right side of the ledger (the credit column).
It's also important to ensure that all entries are accurate and up-to-date. Any discrepancies in your accounts receivable can affect the accuracy of your financial reporting and potentially lead to legal issues.
When do you use a debit or credit for accounts receivable?
When working with accounts receivable, you should use credit when creating an invoice or entering a bill since this increases the amount of money owed to your business.
You will then use a debit when payments are received from customers. This decreases the amount of money that was initially owed to your business and brings the balance back down to zero.
It's also important to note that payments are not always received in full. In this case, you should still use debit for the amount that was paid and leave the outstanding balance as a credit in your accounts receivable ledger.
Good record-keeping is essential
When it comes to managing accounts receivable, good record-keeping is key. The more organised your accounts receivable are, the easier it will be to track outstanding payments and keep up with your business's cash flow.
If you're using an accounting software system, make sure to regularly update the entries in the accounts receivable ledger so that all of the information is accurate and up-to-date.
Finally, don't forget to review your accounts receivable ledger every now and then. This will help you ensure all payments are being made on time and that your business's financial health is stable.
What to remember when handling accounts receivable
Now that we've gone over the basics, here is a quick recap of the key points to remember when managing accounts receivable:
- Accounts receivable represents money owed to your business by customers
- Debits and credits are two separate entries that you make on the left and right sides of your accounting ledger
- Debit entries increase assets or expenses, while credit entries decrease them
- Accounts receivable are debits and credits since they involve two different types of transactions: the customer ordering goods or services and paying for them
- When applying a debit or credit to your accounts receivable ledger, remember to add amounts on the left (debit) side and subtract amounts on the right (credit) side
- Always make sure your accounts receivable entries are accurate and up-to-date
Following these steps will help you stay organised and ensure that your business is in good financial health.
Why accounts receivable management is so critical
When it comes to the financial health of your business, accounts receivable management is crucial.
Not only does it help you keep track of payments and cash flow, but lets you identify customers who are slow to pay or taking too long to make their payments.
With the right accounts receivable system in place, you can improve your cash flow and maximise profit potential by getting paid faster.
There is also a range of tools and strategies that you can employ to help you stay on top of your accounts receivable, including:
Effective management of your accounts receivable is vital and resource intensive. Employing automated accounts receivable software, like Chaser's market-leading platform, will help you save time and effort in managing your receivables.
From sending automated payment reminders to providing actionable insights to improve your processes, an automated accounts receivable system can help you reclaim the time you spend chasing payments.
Early payment discounts
Offering early payment discounts for customers is a great way to incentivise them and encourage them to pay on time. This will enable you to get paid faster and help free up cash flow that would otherwise be tied up in receivables.
At the same time, you can also implement late payment fees for customers who are slow to pay. This will reduce the amount of time you have to spend chasing payments and generate additional revenue.
Key performance indicators (KPIs) are a great way to track your accounts receivable performance.
By measuring metrics such as payment frequency, customer delinquency, and average collection period, you can get an insight into how effective your receivables management process is and identify areas where improvement is needed.
Credit terms are the payment deadlines that you set for customers. Setting clear and reasonable credit terms will help ensure that payments are received on time and prevent any disputes over late payments or missed deadlines.
It's important to review your credit terms periodically, especially if you've recently had an increase in late payments from customers. You may need to adjust your credit terms to ensure that customers are paying on time and help you manage your cash flow.
Keeping on top of your cash flow
Accounts receivable management is essential for any business that wants to remain financially successful. By following the steps outlined above, you can ensure that your accounts receivable ledger is accurate and up-to-date and help improve overall financial performance.
Accounts receivable are an important part of any business's finances, so it's crucial to understand how to manage them correctly.
By understanding the basics of debits and credits, creating accurate entries on your accounts receivable ledger, and staying organised with your record-keeping, you can ensure that your accounts receivable remain in equilibrium and your business's financial health is stable.
By managing your accounts receivable properly, you'll be able to keep a close eye on how much money is coming into and going out of your business. This will help you remain financially secure while growing and scaling your business.
For more information on effectively managing your accounts receivable, check out Chaser's blog. For an insight into how Chaser's automated platform can help you streamline your accounts receivable system, book a demo today or sign up for your no-obligation 14-day free trial!