“Cash is king.” No doubt every small business owner has heard that. That’s because a small business can’t survive without cash flow. All the great talent means zilch if you can’t pay them and your bills.

But what brings in the cash? Your accounts receivable, or A/R. Accounts receivable is an accounting term for what your clients owe you for the products or services you delivered. Your invoices are a generated accounts receivable. Until you submit your invoices to clients, you won’t get paid.

How accounts receivable affects reporting

Here’s the thing about A/R in accounting. When you create an invoice after completing the job, it shows up in the balance sheet as an asset. Let’s say you generated an invoice for $1,000. Your balance sheet shows you have $1,000. However, your bank account hasn’t grown by $1,000 … yet. So you can’t spend the money even though it appears as an asset.

The other thing about assets is that it doesn’t mean your business is profitable even though it’s counted when determining profitability. Profitability consists of all your assets subtracted by your accounts payable or liabilities, the money you owe suppliers and vendors. If you have more assets than liabilities, then your company is deemed profitable. If it’s less, then it’s time to review your company’s reports to figure out how to increase assets.

You can have an accounts receivable, and it may or may not be paid. You can also have an accounts payable and it may or may not be paid.

Hence, you need three reports for the full picture of how your business is really doing:

• Balance sheet: Captures current assets, liabilities, and ownership equity in a single point of time.
• Profit and loss statement: Shows how much money flows in and out of the business. Also referred to as income statement.
• Cash flow statement: Snapshot of the current state of cash in your business.

Without the cash flow statement, you can’t be sure you have the money in the bank. An accounts receivable becomes an asset even if you haven’t been paid yet. That’s why cash flow management is critical.

How to stay on top of accounts receivable

That said, it’s critical to monitor your accounts receivable. You don’t want your invoices to slip through the cracks. Unsent and unpaid invoices don’t turn that asset into cash. Until the money is in the bank, you’ve essentially provided your product or service free.

Here are three ways to effectively manage your accounts receivable.

1. Develop processes

After completing a job for a client, when do you invoice the client? On the spot? End of the month? Same day every month? A small business with effective processes sends its invoices on a consistent basis.

Who creates the invoices? When? How? Who checks for aging invoices? When? How? Who ensures clients receive the invoices? Who follows up with clients who haven’t paid?

The answers to these questions will get you started in documenting your accounts receivable process and the people responsible for each task. It doesn’t have to be complicated. A simple checklist will work.

2. Get everything in writing

Document all your processes, accounts receivable, work orders, agreed-upon terms, and client communications. These provide support in case you need to take legal action. It also gives your bookkeeper or accountant the needed information for creating reports and preparing for tax season.

3. Communicate with clients

One of the most important tasks is to confirm clients have received your invoice. Include this in the process. Sometimes invoices get lost or the client has been out of the office for a long time. Be sure to add a timeframe for follow ups in the process. It could be one week or two weeks. Sooner is best, but not too soon that the client hasn’t had a chance to receive and review the invoice.

These follow ups also give you a great opportunity to nurture your client relationship. Use it to ask for feedback on the job. What’s working? What could be better? What’s missing?

The good and bad side of accounts receivable

You need accounts receivable in order to receive cash and maintain your cash flow. However, in the accounting world, it can mislead you on how your business is doing. Your company can show profitability on paper, but the bank account could be in danger depending on the timing and actions of the accounts receivable and accounts payable processes.

If a small business has $5,000 in accounts receivable that has not been paid, yet $6,000 in accounts payable that it’s about to pay … then there’s going to be a cash flow problem. They money isn’t in the bank until the company submits invoices and receives payment. It’s all in cash flow management and timing.

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