The 9 steps in the accounts receivable process

1. A customer makes an order

When a customer expresses their intent to purchase, they’ll send you a

purchase order (PO). Once you’ve approved the PO, you’ll create a sales
order (SO). A sales order is a binding agreement with the customer that
covers:

 The goods and/or services you’re selling to the customer

 The quantity and price of those goods/services
 The delivery date and location
 Any terms and conditions of the sale

Before you send the customer the sales order, your credit manager or
credit department will review and approve it.

2. You approve the customer for credit

When you sell on account, you agree to extend credit to your customers
and collect payment later. Most business-to-business (B2B) purchases are
made on account.

Because there’s an inherent risk in giving customers credit (customers

don’t always pay their invoices, leading to bad debt), businesses need to
assess each new customer's creditworthiness before fulfilling an order.

You’ll do this through the credit application process, which can take
several days. Your business should have a documented credit policy,
which you’ll use to assess customers’ credit risk. Your risk tolerance may
vary depending on your business’ size, margins, and current cash flow.

If you determine that a potential customer isn’t a good fit for receiving
credit, you might arrange alternative payment terms like cash on delivery.

3. You send the invoice

Unlike a sales order, an invoice is the definitive record of a customer’s

purchase; it details how much they owe, and by which date they need to
pay. Depending on your business’ specific credit practices, this could be
30, 60, or 90 days. If you charge a fee for late payments, it’s very
important that you express this clearly in the invoice.

Accounting teams will typically create their invoices in their ERP or using a
program like Microsoft Word or Excel, then deliver them to customers by
email, electronic data interchange (EDI), or regular mail. The faster you
can get your invoices out the door, the better. The longer it takes
customers to receive their invoice, the more time goes by before your
payment terms officially start.

For this reason, it’s in your best interest to eliminate as much manual
work—like printing invoices and stuffing envelopes—as possible from your
billing practices.

4. You manage collections

Some portion of your customers will inevitably pay their invoices late. To
increase your chances of collecting on unpaid invoices promptly, it’s
important to have your collections staff follow up with customers at
regular intervals.

Below are some time frames commonly used by companies for carrying
out their collections outreach:

 <7 days past due: First contact with the customer to provide a
gentle reminder about the payment
 8–14 days past due: Second contact with the customer
 15–30 days past due: Third contact with the customer; an
official dunning letter can go out stating the payment is 30 days late
(late fees may also kick in after this time)
 31–45 days past due: Fourth contact with the customer; if the
request is still unactioned a final letter can go out
 46–60 days past due: Continued outreach (for example, every 5
business days)
 61–90 days past due: If the request is still unactioned at this
point, you may want to involve senior management, legal counsel,
or a collection agency for help pursuing the debt (if the amount
owed is worth it—if not, you’ll simply write off the amount as
uncollectible)

Before beginning your collections outreach, you should first investigate

the late payment to determine if it’s the result of an internal error. It’s
possible the invoice was never sent, or the customer was promised a
discount that wasn’t reflected in the invoice.

It’s also a good idea to review a customer’s payment history before

springing into action. If a late-paying customer has a history of paying on
time, you can be more lenient to preserve an already positive working
relationship. If a late-paying customer is routinely late, however, then
you’ll want to watch them closely and work with them on a specific
payment plan.

As you’ll see in the flow chart below, some steps in the collections
process are circular, as you’ll carry out the same actions until you receive
the payment or deem it to be uncollectible.
The accounts receivable collections process
This flow chart provides an overview of the accounts receivable collections
process and when to conduct your outreach.

5. You investigate and address any existing disputes

Invoice disputes are one of the biggest causes of late payments. If a

customer has an issue with their order, they’ll want to resolve it before
releasing any funds to you.

In a survey of 1,000 C-level executives on the status of their AR

processes, we found that the most frequent cause of invoice disputes is
human error in the payment process. Fifty percent of executives cited this
as a cause.

Close behind were issues with goods or services provided (reported by

46% of executives), discrepancies between proposals and invoices (46%),
and communication issues (41%).

Customers will often pay the portion of their invoice that’s not in dispute
(a short payment), which adds another layer of complexity for your AR
team. They’ll have to confirm why the short payment happened, whether
it was for a valid reason, and how to apply the payment in your
accounting system.

Your AR team should kick off the dispute investigation process as early as
possible (as soon as an invoice becomes overdue) to prevent payments
from getting delayed further and preserve customer relationships.

6. You write off any uncollectible debt

Your chances of collecting on outstanding invoices decrease as time goes

on. When you’ve exhausted your outreach efforts (including passing off
the debt to a collection agency or legal counsel) and determine the
payment is uncollectible, you’ll write off the receivable as bad debt.

Under accrual basis accounting, companies plan for a certain portion of

their accounts receivable to be uncollectible by setting aside an allowance
for doubtful accounts.

The point at which you deem an invoice uncollectible will vary by your
industry. For some industries, like transportation services for example, an
average days sales outstanding (DSO) of above 50 days is normal. If late
payments are common in your line of work, it makes sense to wait before
writing off an invoice as bad debt.

Average DSO by industry

Dun & Bradstreet and Credit Research Foundation: Accounts Receivable
and Days Sales Outstanding Industry Report Q3 2021
7. You process the payment

Business buyers pay their invoices in several ways, including:

 ACH or EFT
 Wire transfer
 Debit, credit, or virtual card
 Checks

Businesses that want to accept payments online will need a payment

processor, payment gateway, and at least one merchant account, not to
mention a platform to support ecommerce or self-service customer
payments. Some payment services providers will wrap all of this up into
one offering.

Most B2B businesses still accept a significant volume of paper checks,

with a recent survey by AFP pointing to 92% of organizations continuing to
use checks for incoming payments. To support this, businesses will often
resort to managing multiple lockboxes (where a bank receives and
processes checks for you).

Note that although lockbox services eliminate the need for you to receive
checks at your office, they don’t take away the effort involved in
processing them. Going through lockbox files to apply payments to
invoices still takes work.

8. You post the payment to the corresponding invoice(s)

After you receive a payment, then comes the process of cash application,
where you’ll record that revenue in your accounting software.

When a payment comes in, you’ll record the transaction in your accounts
receivable ledger as a credit, deducting the amount from your remaining
unpaid receivables.

To do this, you need to be able to match payment information to the right

invoice(s) and record any relevant credits or discounts before closing out
the receivable in your ERP.

There are several factors that can complicate this step, such as:

 A payment arriving without any associated remittance advice

 Remittance advice provided separately from its payment (as is the
case with ACH and wire transfers, in contrast to checks)
 Remittance information not matching any open invoices

In these cases, AR staff have to reach out to the customer to get clarity on
how they should apply their payment, as you’ll see in the flow chart
below.
The cash application process
This flow chart provides an overview of the cash application process, and
when AR staff requires customer input on where to apply their payment.

9. You report on the status of your AR (ongoing)

During the month end close process, your finance team will check that
they’ve recorded all transactions and put the closing balance of
all general ledger accounts into a report (a trial balance). This allows you
to put together financial statements for that period to report to the rest of
the company.

Reviewing the status of your AR is also something you can do on an

ongoing basis. How frequently you report on collections might depend on
the size of your company and your AR team’s bandwidth. For updating AR
aging reports, once a month (or more often if you can) is a good time
frame to aim for.

There’s a variety of metrics you can use to assess the health of your
accounts receivable. In a recent survey we conducted with SSON, we
found that the metrics most frequently used by businesses to gauge AR
performance are DSO, staff productivity, and collections effectiveness
index.

Every business will have unique challenges and priorities, so we advise

you to come up with your own set of key performance indicators (KPIs) to
track on an ongoing basis. (If you need help mapping those out, check out
our AR Performance Toolkit)
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