Business LoansHow Accounts Receivable Financing Works

What Are Debts Owed To A Business Referred To As?

debts owed to a business referred to as

What are debts owed to a business? Accounts receivable

Accounts receivable is the money that a customer owes to a business for the goods or services that were provided. It’s an accounting term that is referred to as “AR” and represents outstanding invoices that haven’t been paid. This is unlike money that a business owes to vendors, which would be called accounts payable. It also is part of the cash flow during your business’s fiscal year.

These unpaid invoices are important to your business because if too many of them mount, everything you worked hard for could be threatened. Not only could you get behind on your bills, but your credit rating could also suffer as a result and you could possibly lose your business. For these reasons, it’s imperative that you stay on top of the money that your business is owed.

How to record accounts receivable

A balance sheet provides you with a picture at a single point in time of your business’ assets, liability and net worth. On your company’s balance sheet, the accounts receivable would be listed as an asset since your customer is obligated to pay you for the product or service you provided. It would be called a current asset because the balance due from that debtor would be one year or less, according to Investopedia.

Here’s a way to look to understand it better: Say that you operate a wholesale business selling one-of-a-kind graphic T-shirts to retailers. One of your customers wants 1,000 shirts and you negotiate to charge $3 per shirt. When you ship those 1,000 shirts to that retailer, you will include a bill for $3,000, which is owed to you. That retailer has received the shirts but you haven’t received the money that is legally owed to you. The $3,000 would be documented as an account receivable on your balance sheet. Accounting Coach noted that if you required the company, or the retailer in this case, that owes you money to sign a promissory note, then it would be recorded on your balance sheet as notes payable.

Understanding basic accounting principles will help you to understand a balance sheet along with income statements and cash flow statements. You can easily create a balance sheet thanks to accounting software.

Three reasons a business is owed money

1. Businesses that extend lines of credit

You can use your company’s accounts receivable as collateral for commercial lines of credit. This is called accounts receivable financing and occurs when a lending institution loans you money based on the unpaid invoices your company is due. Many lenders offer this type of asset-financing arrangement to borrowers and usually “advances companies 70 to 90 percent of the value of their outstanding invoices,” according to Investopedia.

2. Frequent purchases with one payment

Most companies allow customers to use credit for a portion of their sales. Sometimes, businesses offer this credit to special customers who frequently buy from them and send those customers periodic invoices. This method enables customers to avoid the hassle of physically making payments for each purchase.

3. Post-service payment structures (electric companies)

You’ve made it this far with your small business, so why let an inadequate payment structure lead to your downfall? If you offer post-service payment, it’s important that you have efficient and organized means to collect your debts. You and your customer should have agreed upon payment terms that clearly outline dates and the dollar amount you will be paid. The terms should also not exclude any late fees that will be accrued or termination of services that could occur. You should have the payments automatically debited from their accounts, which could ensure you get paid on time. You could also send electronic reminders via email or text at specific dates and have late fees generate automatically when deadlines are overdue.

Sometimes emails and text messages get ignored and calling people the old-fashioned way may be the best way to remind customers about their balance and upcoming or past due payments. Whichever post-service payment structure you decide to implement, it’s important to appear organized and professional when dealing with your clients. This is your business and if you appear lackadaisical, customers could sense it and decide to pay you at their leisure instead of honoring the term agreement.

 

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5 ways to decrease your accounts receivable

1. Perform credit checks on vendors and clients

You may be hesitant to ask a client or vendor about their credit score, but doing so may save you time and help you avoid potential headaches down the road. Consider having an application where you require them to include their Employer Identification Number (EIN) or Social Security number and let them know you may perform a credit check. You could also ask them to list delinquencies in their credit history that could affect their score. It never hurts to ask them for references or check their reputation with trade organizations or others who may have done business with them.

2. Include a clear payment policy

You’d be surprised how many businesses are afraid to ask for money that’s rightfully owed to them. Don’t be that business owner. One way to be upfront is to establish clear payment terms and enforce them. This would also include fees instituted when the agreement has been broken such as late fees, return check fees and other fines.

3. Provide detailed invoices

We all live busy lives and sometimes those things which deserve more of our attention occasionally fall through the cracks. This includes the debts that those owe us. Sending clients detailed invoices not only reminds them of the services rendered but also lets them know what’s been paid and when so there isn’t any confusion about the balance that’s owed to you. If your client is on a payment system, you want to include the dates payments are due.

4. Automate where possible

Automating your customers’ payments can ensure they pay off any balance they have with your company by the agreed upon date. Setting up these recurring payments is a pretty streamlined process that requires your customers to provide banking information such as the name on the account, checking account number and the bank’s routing number or credit card information. Automated Clearing House (ACH) is an example of an electronic payment system that’s used for automated debits. Also, let your customers know that you accept funds via online payments system like Paypal or a bank-to-bank transfer.

5. Know when it’s time to write off a debt

Unpaid invoices are a drag for small business owners. But they occur and it’s important to know when to write them off as bad debts. This is especially important if you don’t want the Internal Revenue Service to challenge your claim. It’s recommended that you consult your accountant about whether your unpaid revenues can be written off but, according to the IRS, “to deduct a bad debt, you must have previously included the amount in your income or loaned out your cash.” If your business uses cash-method accounting, the IRS states you generally “can’t take a bad debt deduction for unpaid salaries, wages, rents, fees, interests, dividends and similar items” because those revenues and expenses are recognized once the cash is received. On the other hand, accrual-method accounting records payments when they’re billed instead of when the money is collected, and is the method the IRS requires you to use if you want to write off a bad debt. It’s also important to note that the IRS requires businesses to use the accrual method if they have “over $5 million in sales per year or over $1 million in gross receipts for inventory sales.” Businesses must use the same method for tax reporting as they do for their own accounting records, according to the IRS website.

 

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