Accounts receivable have a direct impact on the cash flow of a construction project. The construction firm is likely in financial trouble if its accounts receivable are poorly managed.
When a construction company has finished a job or task but has not received the money yet, that money is called accounts receivable.
Normally, receiving payment in the construction business takes longer than in other industries. In general, 1 in 6 construction businesses will suffer from late payments (according to the 2022 Construction Cash Flow Payment Report). It takes them 60 days or more after invoicing to get paid.
Business owners should therefore understand and appropriately manage their accounts receivable. This post will define accounts receivable; explain where they are recorded, and tips for contractors to get paid faster.
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What is Accounts Receivable?
Accounts receivable (AR) represent the money owed to you by clients who have received your services but have not yet paid. This money is typically collected within a few weeks and is recorded as an asset on the company’s balance sheet.
Understanding Accounts Receivable
As mentioned above, Accounts Receivable is any cash your clients owe you for goods or services you provided prior. It also represents a line of credit extended by a company and has a term that requires payments within a relatively short-term period. The period ranges often from some days to a fiscal year.
Accounts Receivable are recorded as an asset on the company’s balance sheet because of the legal obligations for the customer to pay the debt. As a rule, it is a current asset that suggests the account balance is due from the debtor in a year or less. If it takes a receivable longer than a year for the account to be converted into cash, it is recorded as a long-term asset or notes receivable on the balance sheet. Under the accrual basis of accounting, the account is offset by an allowance for doubtful accounts, since there is a possibility that some receivables will never be collected. This allowance is an estimate of the total amount of bad debts related to the receivable asset.
Is Accounts Receivable an Asset?
Yes, accounts receivable are assets since they are customer debts that can be converted to cash. Accounts receivable are a type of "waiting" cash flow in construction accounting. It is money that is legally yours but has not yet been literally handed to you.
Is Accounts Receivable a Revenue?
It is essential to remember that accounts receivable are an asset, not a revenue. Companies use AR to follow up on payments, and track invoices for each project. In a way, AR is a loan. When you lend somebody money, that money is your asset, not revenue.
Accounts Receivable vs. Accounts Payable
Investors will look at these two criteria to assess your company's financial health; yet, these metrics do not serve the same purpose. Accounts receivable are assets, meanwhile, accounts payable are considered liabilities.
Simply defined, AR reflects the money that your customers owe you. AP, on the other hand, refers to money you owed to other firms.
For example, suppose you bill your consumers for a completed service. You send them your invoice for $2000. When your client receives the invoice, he'll record $2000 as accounts payable because he owes you $2000. Meanwhile, your bookkeeper will record the $2000 as accounts receivable on your end.
Key takeaways - Accounts Receivable is an asset account on the company’s balance sheet to reflect money due to a company in the short-term. - Accounts Receivable is created when a company lets a customer purchase their goods or services on credit. - Accounts Receivable are similar to Account Payable. However, instead of money to be paid, it is money to be received. - The strength of a company’s Accounts Receivable can be analyzed with the AR turnover ratio or days sales outstanding.
Where Do You Record Accounts Receivable?
Accounts Receivable are recorded as an asset on the balance sheet. It's a current asset if the debtor must pay the balance within a year. If it takes longer than a year to turn a receivable into cash, it's classified as a long-term asset or notes receivable.
Balance sheets show a company's finances at a given date. It shows assets, liabilities, and equity. The balance sheet is so named because the account totals must balance. The report uses the accounting equation assets = liabilities + equity. The balance sheet includes Assets, Liabilities, and Equity.
Why Account Receivable is Important in Accounting?
Accounts receivable are significant since it has an impact on your financial state. On a construction site, late or non-payment may be the biggest concern. If you procrastinate, your construction company may face greater financial threats. Delays in payment can threaten the survival of your construction firm.
Think of your customers' accounts receivable as small loans. With this in mind, contractors should always follow up on the receivables, especially those that are late. Some companies simply are unaware of how much cash is stuck in their balance sheets.
How to Get Paid Faster?
Clarify Credit Policies and Penalties
A strong credit strategy is vital for protecting contractors, subcontractors, and suppliers from financial risk due to late payments. If you don't get paid when your job is done, you're offering your client a loan.
There is nothing wrong with loans, but you must specify the terms and consequences if your client fails to meet them. Set parameters for your credit policy from the start so your clients are more likely to take their responsibilities seriously and pay you on time.
Early Payments Get Rewards
One way to get people to pay you sooner is to encourage them with rewards. Offering an incentive for early payment can get you paid faster and reduce your customer's costs.
Contractors can tackle this efficiently in numerous ways:
Discounts and incentives
Give free service maintenance as an example.
Future credits for early payment
Optimize the Invoicing Process
Sending invoices by hand takes time and is prone to errors, both of which hurt a company's bottom line.
Construction accounting software is now being updated and is capable of resolving these issues. The use of software improves the accuracy, timeliness, and efficiency of the invoicing process. Invoices can be sent automatically once the projects are completed, minimizing the need to stick to a monthly billing cycle.
You might use invoice software or hire a construction accounting specialist to handle the invoices for you. You can learn more about these solutions at CCA services, where a devoted and knowledgeable staff is available to assist you wherever you are.
The Bottom Line
Now, if you're familiar with accounts receivable in construction but aren't sure how to handle it, schedule a free consultation with CCA so that we can give you leading bookkeeping services for your construction project.
