Accounts Receivable
Welcome to another episode of The (Not Boring) Boring Small Business Bookkeeping and Accounting Podcast (And I’ll try once again to live up to that long name). I’ve survived the September 15th deadline, so I’m just glad to be here this week. I’m Paul Rosenblum.
Last week we talked about Accounts Payable, which is money that you owe vendors for products or services. Today, let’s speak about Accounts Receivable – money that is owed to your company.
Just like Accounts Payable, Accounts Receivable is an ‘accrual’ account. On the payable side, there are Vendor Bills, and payments of those bills. On the receivable side, there are customer invoices representing the services or products that you sell to your customers and payments from customers that have to be entered into your accounting system correctly. If you have a cash only kind of company (such as a street vendor, or website sales), then you wouldn’t necessarily need to ‘invoice’ a customer. They would all pay at the time of the purchase of a product, or the services rendered. But many companies are mixed. They have customers or clients who pay at the time of the service, as well as customers who like to get invoiced and then pay later. As I mentioned with the payables in the last episode, cash flow is something that you always have to think about as a business owner. If you accrue $25,000.00 of vendor bills due 30 days from now, then the idea is to have enough money in the bank in collected sales to pay the vendors on time. So, running reports on the receivable side is equally as important as the payables.
The IRS requires just one figure that represents your income or ‘revenue’. However, in bookkeeping, you can have as many sales accounts on your chart of accounts as you would like to be more specific on how you made your revenue. However, very easily you can have 15- or 20-income accounts, which makes your Chart of Accounts longer than it should be. (I try to keep the chart of accounts short enough so the profit and loss report will be one page long (at least for my small to medium sized clients). Most computerized accounting software solves that problem by having the bookkeeper create ‘items’ of services and/or inventory that you sell your customers. Each item is then attached to an income account on the chart of accounts and the ‘items’ are now line items on a customer invoice. So, if you use one income account on the chart of accounts (COA), it’s perfectly fine -- you can run reports on the ‘items’ that you created when you first started selling products or services. It’s important to business owners to know ‘how’ they made their revenue, but pretty unimportant to the IRS, but I digress to another episode yet to be recorded). Similar to the Accounts Payable reports, the Accounts Receivable reports are separated into columns. The default columns represent the current invoices (not overdue for customers to pay), 1-30 days overdue, 31-60 days overdue, and 61-90 days overdue. It’s important to keep a very good eye on that, because if a customer gets to the point where they are 90 days overdo on paying an invoice, it generally gets harder and harder to collect on that debt from the customer.
As your company grows, you could hire someone whose primary job is to keep track of the payables and the receivables. It could be a part time position or a full-time position, depending on how large a company you have.
Earning money is just half of a healthy business. Collecting money owed to you is the other half.
In some industries, it could be customary to have people pay ‘deposits’ on work that isn’t started yet, almost like a retainer that lawyers take in before they do any work on your case. Then as they work, the bookkeeper accounts for the retainer money and converts it into a revenue account when earned. So, the bookkeeping is much more detail oriented because up-front deposits or retainers which are booked as liabilities, have to be moved to a revenue account after they are earned and no longer refundable. (Hence, the liability account) But I again, digress.
However, if you aren’t in that kind of business, the customary thing to do in many cases is to make the sale, invoice the customer, and receive payment at another time. This is what Accounts Receivables are.
One has to look at the monthly expenses that the company has and the amount of money that the company has in monthly sales. The sales should be higher than the expenses. (That’s the idea anyway for a profit-making business model) So, as mentioned, sometimes the expenses end up being reasonable, but the income just needs to increase in order to pay the bills and get some profit. Accounts Receivable will show the income earned, but not yet collected. In accrual accounting, the Profit and Loss report (run in Accrual mode) will show collected and uncollected Accounts Receivable as well as cash sales going directly into the bank -- all showing up in your sales or revenue.
As the business grows, the owner(s) don’t really get involved with the payables and the receivables very much, although they might still approve some bills as ‘ok to pay’ or tell the staff to not make any more deliveries to a certain customer until they pay their invoice(s).
Even if your taxes are cash based and not accrual based, and the accounts receivable and accounts payable aren’t reported on the tax return, they are equally important if you are entering bills and customer invoices within your accounting system – even if you are running cash-based reports for tax purposes.
You can also change the terms on the receivable side. You don’t have to have a standard net-30 on every customer that you sell to. For some customers, you can have a due on receipt, or a net 10 (due in 10 days, for example) or 50% downpayment before you do any work, and the second 50% due at the completion of the job. You can have phases on a job. If the job is going to take you 3 months to complete, then you can have either one invoice explaining that Phase I is due on receipt, Phase 2 is due in 30 days, and Phase 3 is due in 45 days or at completion (and as payments come in, they would be partial payments on that large invoice)– or have 3 or 4 separate customer invoices.
Receiving payment by credit card could be a plus as well. People will generally
pay faster using a credit card if they don’t have enough cash flow or money in the bank to pay the full amount. However, you have to figure in the merchant costs (anywhere between 1 and 3.5%) that you are charged by the credit card company to accept that payment from a customer.
But again, sometimes it just comes down to earning more money than your company spends.
From an accounting viewpoint, if your company is on a cash basis, when you run cash-based reports for the accountant or tax preparer at the end of the year (or beginning of the next year), you should NOT see Accounts Payable or Accounts Receivable on that cash-based report. If you do, the bookkeeper needs to fix that (or at least explain as to why it’s there)
Two client examples about this:
- I had a client who was doing her own bookkeeping and working with a ‘bookkeeper’ (and I use that term loosely)! (((sound effect))) who was entering invoices for sales but accepting the downloaded payment from the bank directly to income rather than applying that payment to the unpaid invoice. This left the accounts receivable invoice open and unpaid but also added revenue to the profit and loss. The same company had situations where an invoice was made for $469.00, but the customer paid $500.00 to round it off. That customer then had a negative balance on the accounts receivable ledger. If you have a situation like this, then the ‘overpayment’ of a customer invoice can either be applied to the next invoice for that particular customer, or, if there will be no more invoices for that particular customer, counted as revenue for that year by the tax preparer. The problem is that accountants at tax time putting together a tax return for a cash-based tax return don’t even look at the accounts receivable -- Hence they don’t know about the overpayments and other situations in accounts receivable. With this client, when I started working on the books, we found about $35K dollars of income recorded as accounts receivable with no invoices ever created and had to count that $35K as revenue for the current tax return.
- The second example happened several years ago when I saw about a negative $120K in accounts receivable with a cash based company. I had to go through line by line in accounts receivable for the entire year starting on Jan. 1 and going to December 31, and a corresponding account called ‘undeposited funds’ to figure out where the discrepancy was. It ended up that an invoice was dated sometime in Jan. of the next year, but the payment was received in December. Many accounting systems let you create an invoice later than the actual payment comes in, but if you are running reports as of 12/31, in this case, the invoice wasn’t showing up as of 12/31, but the payment was. It was skewing the accounts receivable for the previous year by creating a negative number on the receivables.
By the way, I am currently working on a YouTube channel to launch soon where I will post some screen shares on specific examples in accounting so that you can ‘see’ what I am talking about, and not just ‘hear it’ here.
Since it’s almost time to invoice my clients for the month, I’m getting back to my own receivables now, and dotting my I’s and crossing my T’s before I email all client invoices so I can pay my producer and all of MY bills!
Accounts Payable and Accounts Receivable are the backbone of most businesses, even if on a cash-based tax return. It’s all about money in-money out -- ‘cash flow’!
Happy Payables and Receivables all!
Next up: I’m working on a special episode that was suggested to me about ‘why’ I’ve started this podcast to share with you adding to my already full-time bookkeeping practice. So, stay tuned.
But right now, I’m feeling the pressure of the October 15th IRS deadline – so I’m gonna run and get back to work! - I’m um…. I’m … still Paul Rosenblum, I think!