A Guide to Accounts Receivable and Accounts Payable for Small Businesses in India

One of the most important and often overlooked factors that define whether a small business will be successful or not is keeping a tight rein on cashflow. Your product might be great, but if you don’t have the cash to cover your day-to-day running costs, it won’t matter how many orders there are in your order book. 

For this reason, managing your accounts receivable and accounts payable is vital to the health and future development of your company. This guide is specifically aimed for small to medium sized businesses (SMBs) in India, that are working with international clients or suppliers, and therefore managing accounts receivable and payable which involve handling global payments and foreign currencies. 

Platforms like Payoneer are ideal for these types of cross-border transactions. Let’s jump right in.

What are accounts receivable and accounts payable?

If you’re new to international business and global payments, the first thing is to have clarity as to the meaning of accounts receivable (AR) and accounts payable (AP).

• AR is the balance of money owed to a company or business for goods or services already provided but not yet paid for. The customers for these goods and services have had them on credit, with the understanding that they will settle for them within a specified time period. The sum total of these outstanding invoices is known as AR, and the time periods over which this credit is extended can vary from a few days to several months. Examples include sales made on credit, subscriptions, and installment or lay-bye payments.
• AP is the money that your business owes to suppliers from whom you’ve received goods or services on credit. Like AR, these outstanding invoices will need to be paid by a specific date or after a specific period of time has elapsed. The total of these outstanding invoices is referred to as AP and is a liability against your business.

Although it might seem to make more sense for businesses to pay their invoices immediately upon receipt of goods and services, there are many reasons why credit can be desirable. For example, if you need to buy raw materials to make the goods you later sell, buying them on credit means you could put off paying for them until you’ve received the money from selling the finished products to your customers. In this way, you’re using AP to finance the manufacturing process – very much to your advantage, especially if the alternative might be to take out a loan and incur interest charges over the time period.

On the other side of the coin, you might want to offer your customers credit for a number of reasons – as an inducement to buy from you rather than your competitors, or to allow you to reduce costs by issuing fewer invoices and incurring fewer transaction fees if they buy small amounts often. 

Why accounts receivable and accounts payable matter

Regardless of your accounts receivable turnover, if you don’t have the day-to-day cash you need to run your business, you’ll run into financial trouble. Every company has regular outgoings – staff costs, rent and utility bills, supplier and contractor payments, and if you make goods, the purchase of raw materials. Some of these can be taken on credit and form part of your AP, but some can’t. You need to pay your staff in a timely way, and there are always some suppliers that won’t extend credit. And of course, there will always be the unpaid invoices in your AP that become due for payment.

This means that you need a flow of income, either from invoices paid immediately or AR invoices become due — and this flow of income needs to come in at a rate that allows you to service your outgoings. Good record keeping is critical to staying on top of cashflow. You need to be able to forecast with accuracy what your income and outgoings will be, month by month, so you can ensure that income doesn’t fall behind, leaving you in need of a costly overdraft or loan just to stay afloat. Timing is everything. 

Accounts payable vs accounts receivable in accounting

Both AR and AP will show up on your business balance sheet. AR is an asset to your business as it represents future cash, while AP shows up on the liability side as it’s money that you owe to others.

If you have investors, or if you intend to borrow money, these details will be important. They contribute to the overall value your business is calculated to have, and give an indication of ongoing cashflow, which lenders and investors will want to see. AR is particularly important, as the debt it represents could be sold to a third party to ensure the business can weather any short-term cashflow problems. This process is referred to as invoice factoring, and it contributes towards your company’s liquidity.

A large AP balance on your spreadsheet isn’t so encouraging. Missing these payments can incur added interest or late fees and can damage the payee’s trust in your company. Additionally, if the liability is large, investors may read it as a potential future problem, as you will be expected to pay off these invoices, regardless of the level of cash coming into the business.

Paying your AP invoices is something within your control – keep good records and set reminders of when payments are due. AR collection, however, is another matter and not fully within a business owner’s control.

To make sure you receive payment on time, you’ll need to:

• invoice promptly, stating clearly the payment terms you’ve agreed with the customer
• set up reminders to yourself and your customer as payments become due
• check expected payments have come in on time and chase any that become overdue
• amend your records to reflect payments in and out

Allowing AR payments to become overdue will not only affect your cashflow, but will more than likely incur a range of additional costs:

• a shortage of cash may force you to take out a loan or overdraft, which will incur interest charges
• the lack of cash in your business will have an opportunity cost, as cash may have to be diverted from other projects or activities
• administrative costs can build up if you have to spend time chasing unpaid AR invoices
• you might incur debt collection costs if you have to resort to employing a third party debt collector
• if a customer defaults on payment, you’ll be left with bad debt on your books which will have to be set off against other income
• suing creditors for the payment of debts will be an additional cost burden

Key to being successful in managing accounts payable vs receivable is to negotiate the best terms with your customers, don’t let overdue payments drift and pay your own invoices as they become due. Keeping accurate accounts is also critical, and using a B2B online payment system such as Payoneer can help you to manage and streamline the process.

Simplify the accounts receivable/accounts payable process with Payoneer

By taking care over how you manage your AR process, you can improve your business’s cash flow and maintain good working relationships with your customers. Payoneer is an online payment system that operates in India as well as in more than 200 countries. It enables you to receive payments globally in either Indian rupees or your currency of choice from more than 70 available.

It can also help you track AR and enable you to smoothly manage customer payments and outstanding balances.

Here are a few smart tips for using AR to your advantage:

• If you manage your AR well, it increases the profitability of your company and acts as an accurate guide to incoming revenue. If the liabilities side of your balance sheet overtakes the assets, you can use your AR to generate income.
• AR processes can help your customers to pay their bills on time. Payoneer can track outstanding invoices, monitor customers yet to pay and automate the process of sending reminders.
• By using Payoneer to manage your accounts receivable invoicing process, you can reduce losses caused by bad debt by a significant amount. Our AR process will enable you to monitor customers and give you insight into the way they operate, and whether they’re likely to incur bad debt expense for you. It will also identify good payers for you, to whom you might consider extending further credit.
• These insights will enable you to make provision for any bad debt and protect your business from unnecessary losses.
• Managing your AR through Payoneer becomes a seamless element of your customer service, and it allows you to customize your interaction with them to further strengthen the bond.
• Payoneer’s cashflow reports will identify areas of your business process that are operating well and others that might be in need of improvement.

Another advantage in using Payoneer is gaining instant access to your AI metrics and KPIs. This data can be used to evaluate the efficiency of your AR processes and contribute to your ongoing business strategy and future planning.

These are the AR metrics to look at:

• Accounts receivable turnover ratio – this is your net credit sales divided by the average AR. It measures your success in receivable collection, tracking how often you receive balances owed. A higher turnover ratio indicates effective billing processes, while a lower ratio is an indication that work is needed in this area.
• Days sales outstanding  – this is your total AR divided by your total credit sales, then multiplied by 365. It tells you the average time customers take to pay you and sheds light on the effectiveness of your cash collection strategy. A low DSO means you’re being paid more quickly and that your collection strategy is working. A high DSO means your AR is taking longer to reconcile.
• Best possible days sales outstanding – this is your current AR divided by total credit sales, then multiplied by 365. It differs from DSO as it includes only current AR, rather than total AR, and it shows the average number of days your customers take to pay you, assuming that they pay on time.
• Average days delinquent – this is the number of days sales are outstanding divided by best possible days outstanding. In striving to eliminate overdue accounts, the closer this figure is to zero, the better.
• Bad debt to sales – this is calculated by dividing the uncollected sales figure by the annual sales figure, then multiplying by 100. It shows you the percentage of your revenue that becomes bad debt, and if it’s higher than 25% you need to take desperate action to improve your collection rate. You should aim to keep it below 15%.
• Collective effectiveness index – use this to measure your AR collection efficiency over a specified time period, such as a month or a year. 100% is the goal, but anything over 80% is considered good. You can improve this figure by ensuring you communicate effectively with customers who owe you money and minimizing invoicing errors which could lead to disputes.
• Operational cost per collection – keeping the cost of collecting AR as low as possible contributes to your bottom line.

Payoneer can provide you with all of these metrics and KPIs at the touch of a button, enabling you to keep your AR on track and understand your strengths and weaknesses. 

Use Payoneer to keep your cashflow flowing

When you run a small company, you find yourself wearing many different hats – managing director, finance director, HR, sales and marketing, production – and you’re responsible for making a success of all of them. The core of your business is your passion and that’s where you want to focus your attention, not on accounting, invoicing, making payments and chasing debts. That’s where Payoneer can help. It makes managing the financial side of your business quick and easy. Pay and be paid, wherever, in whatever currency you like. Set reminders to pay your own bills and send them to your clients to make sure they pay theirs. Check the metrics and take action. Payoneer – it’s the easy way to keep on top of AR and AP, leaving you time to attend to business.