Trade receivables are essential to any small business. They can represent good cash flow on an income statement that contributes to the business's profitability or, if poorly managed, could leave a business with unacceptable levels of bad debt.
Trade receivables represent the money owed to you by customers for whom you've provided products or services on credit - often an essential business practice. That's why trade receivables need to be treated with prudent financial practices, reducing risk and increasing the chances of prompt, full payment.
Why Are Trade Receivables Important?
Trade receivables are the foundation of a business's cash flow. If you don't keep track of them during the ordinary course of business, you might miss getting paid for goods or services provided, damaging profitability on your financial statements. On a balance sheet, they are put under your current assets with the expectation that they will be paid off within a year. They provide the clearest indication of your business's income.
Calculating Profitability
Trade receivables are an important tool in calculating your business's profitability. As an asset, they represent money to your company (working on the assumption that customers or clients will pay their bills).
To determine your profitability, you add up all your assets and then subtract your total accounts payable - these are liabilities that you may owe to suppliers and vendors. Other assets might include unsold inventory, unused supplies, investments, cash, and prepaid expenses.
If you are in the black after deducting your accounts payable, your company is profitable. If you are in the red, you need to sit down and think about what measures you need to take to make your business profitable, including improving the performance of underachieving assets and getting your liabilities under control.
Managing Payments and Billing
Managing timely invoices for trade receivables and keeping track of who has paid and when are essential to ensuring you keep your business's cash flow healthy. If you don't keep on top of your invoicing and payments, you risk underperforming as far as reaching profit goals and collecting outstanding money owed.
Trade receivables are best handled regularly, including invoices with shipped products or provided services, with set scheduled follow-ups to ensure payment is made. Keeping on top of trade receivables can make the difference between success or failure for a small business.
Tax Purposes
At tax time, you can realize the benefit of having properly tracked your trade receivables since you have documentation that can be used as proof of income. While the Internal Revenue Service (IRS) doesn't levy taxes directly on your accounts receivable balance, this asset does ultimately contribute to a company's profitability, and profits are taxed.
How you pay taxes on profits depends on what type of company you are. If you are a corporation, you'll pay corporate income taxes on your profit. If your business is a sole proprietorship or partnership, you'll pay personal income tax on this money.
Are Trade Receivables the Same as Accounts Receivables?
Trade receivables are the same as accounts receivable and are listed under current assets on the company's balance sheet. Both accounts receivable and trade receivables yield the dollar figures for goods sold or rendered, which have been invoiced for but not yet paid. The expectation is that they will be paid within a year (though the hope is that they'll be paid much quicker).
Trade receivables and accounts receivable are the opposite of accounts payable (money that your business owes), and so the total for this would represent a liability that would detract from the company's bottom line.
What's the Difference Between Trade Receivables and Nontrade Receivables?
Trade receivables is the money owed to your business for credit sales of products or services. Nontrade receivables is the money owed to your business outside of the products and services sold (e.g., employee loans). They are classified as current assets but can be moved over to noncurrent assets if you expect that it will take more than a year to get them paid.
Here's a chart outlining trade receivables versus nontrade receivables:
| Trade Receivables | Nontrade Receivables |
|---|---|
|
Investments Cash Foreign currency Prepaid expenses Unused supplies and inventory |
Salary advances made to employees Employee loans Income tax refunds Interest receivables Insurance claims |
How Can Trade Receivables Be Reduced?
If your trade receivables are steady or reducing, you're probably on track as far as managing debt owed you, with new invoices going out balanced by payments coming in. However, if your net account receivables are growing, these increasing long- and short-term debts may be cause for concern. To reduce your trade receivables and increase your liquidity, you'll need to look at how you're extending credit, including to whom and which processes are in place to manage it.
Send Invoices Promptly
To ensure prompt payment of trade receivables, you need to send out timely invoices, preferably at the same time that you are shipping goods or rendering services. If you are taking a few days to prepare and send an invoice, it's time to revisit your invoicing, perhaps using a simple but effective invoicing template from Skynova to speed up the process. You can arrange for online payment and see if the invoice has been opened and read.
When sending an invoice, make sure that the customer's information is correct, including their mailing and email addresses and the billing and due dates.
Use and Enforce Payment Terms
Your invoice should also clearly explain the terms of payment so the customer knows how much they owe and when payment is due. Without this, customers may take their time paying what they owe you.
If you need fast payment, you can make the payment term "due upon receipt," but it's best to let the customer know this condition upfront so they aren't surprised by the quick demand. Seven, 15, and 30 days are more typical payment terms. To enforce payment terms, have a collections process put in place to automatically kick in when an invoice is overdue.
Different options for payment can also help speed up the process, with customers selecting the method that best suits them. This includes offering online payment and accepting multiple debit or credit cards.
Consider Discounts and Down Payments
One way to prompt payment is to offer a small discount (say, 5% or a flat-dollar figure) for customers who pay early. Customers will typically appreciate the gesture. Make sure you are clear on the invoice about the date the payment must be received to be eligible for the discount.
If your company offers expensive products or services, you might want to build in some protection for financial loss due to non-payment by insisting that a down payment or deposit is required at the time of the order.
Be Proactive
Unfortunately, the "check is in the mail" claim still happens all too often in the world of business. You wait for payment for an overdue invoice that doesn't come, and this makes payment even later. While you may not want to upset a customer, the fact is that your company sells goods or services that cost you money to provide. The customer owes you money, and you have every right to ask for it. Yes, ask for the money, but if you perceive a problem, don't hesitate to send an unpaid bill to a collections agency - they have the expertise that gives you the best chance of receiving payment.
Let Skynova Help You With Your Small Business Bookkeeping
As a small business, it's often a matter of survival to stay on top of your invoicing and accounting. Using the accounting software offered by Skynova, you can easily invoice customers and track payments, make fast, automatic calculations, have access to a general ledger, and get statements that give you quick insights into the financial health of your company.
Skynova offers the business templates and software products that you need to turn accounts receivable into accounts received.
Notice to the Reader
The content within this article is meant to be used as general guidelines for dealing with trade receivables and their prompt payment and may not apply to your specific situation. Always consult with a professional accountant to ensure you're meeting accounting standards.