Bookkeeping Horror Stories: Accounts Receivable - Part 1

Posted (10/15/24):

Happy spooky season everyone! With Halloween fast approaching, it seems like a good time to resume our series of Bookkeeping Horror Stories. If you’re new here, I’ll be talking about the myriad of ways that bookkeeping can go wrong, and I’ll even reference real scenarios that I’ve seen in my career (with identifying information omitted of course) to illustrate the terrors of bad bookkeeping practices.

In our last segment, we talked about problems that can arise with the Accounts Payable process. While overdue bills are scary, today we’ll be talking about something even more spooky: Accounts Receivable!

Why AR?:

In my experience, accounts receivable (AR) is where most small businesses need the most help. Most small businesses invoice more often than they receive bills. In fact, most businesses would need to have significantly more AR than AP to stay afloat! That is to say that you’ll be dealing with this a lot in your books, and any small problem with your AR can be amplified a lot over time. 

The stakes are also super high when it comes to AR. For many small businesses, accounts receivable is one of the largest assets on their balance sheet, if not the largest. When assessing the value of a business, one needs to be confident in the health of the balance sheet, and specifically the validity of the AR. If the AR is not something that can actually be collected, then the value of the whole business can change dramatically. 

Good AR practices are also vital for keeping steady cash flow. I have personally seen companies that have struggled to pay bills, even as their reports showed they had tens of thousands of dollars that are owed to them in overdue invoices.   

Bottom line: you NEED to get this right. 

The Four Stages:

So let's look at the stages of processing account receivable in order to identify where things can go wrong. There are, generally, four stages to the process.

Stage 1: Creating Invoice

Stage 2: Delivery of Good or Service

Stage 3: Collecting

Stage 4: Receiving payment

Because this is such a big topic, we’ll need to break things up a bit. Stages 1 and 2 are very interlinked, so we will talk about those at the same time today. In a future blog we will look at stages 3 and 4. 

Stages 1 & 2: Creating an invoice and Delivering 

Imagine a company that makes deliveries of inventory to customers. Every morning, they take orders from customers via phone or email request, and then turn those into invoices. They then order the products requested from wholesale distributors and have them delivered to the company warehouse. Once the items arrive, they load the products onto vans and make deliveries to customers. Delivery drivers bring along a printed copy of the invoice and ask the customers to sign each one as it is delivered, and then return the signed invoice to the warehouse for processing. 

Do you spot anything wrong with this process? 

The above description is taken from a real company that I have worked with in the past, and I can tell you there is a lot wrong here.

The first issue at hand in this example is that the invoice was created at the wrong time. No product or service had been delivered at the time the invoice was created. Creating an invoice is a way of saying “such and such owes money”. But that is clearly untrue at this stage in the process. In the model above, an invoice should not be created until the product has actually been delivered. 

But the date being wrong on the invoice may not be a huge deal in some cases. Maybe it just means that the invoice shows as being overdue before that is technically true. That is the best case scenario. 

Missing Items:

Now imagine that after an invoice is created, the company purchaser realizes that they can’t get one of the items that the customer asked for, so they proceed with fulfilling the order to the extent that they can. What happens to that invoice? Will the company purchaser go back and remove that one item from the invoice? They might, but there is nothing forcing them to do so. In fact there is no mechanism in place to even catch this mistake until delivery day. And if there is not a dedicated person to sign off on all shipments that leave the warehouse, then there is no accountability that incentivizes people to flag the item as missing.  

When a shipment is delivered to a customer the customer may catch that the item is missing, but the invoice has already been printed and the other items delivered. The customer is now in a position where they either have to refuse the whole order, which interrupts their service capabilities, or they have to sign an invoice for an order that was not complete. And, even if they mark the item as missing on the paper invoice that they’ve signed, that doesn’t change things digitally. The company books will still show that the customer owes for the whole order. So when a check comes in for only a partial amount of the open invoice total, a balance will be left open that should never have been on the books in the first place. 

Pretty messy right? Well this is the exact situation I as a bookkeeper had to clean up time and again with a company I previously worked with. When I came into the company, there were hundreds of partially paid invoices on the books, and I had the task of going through each one to try and determine if the fault was on our end, or if the customer had paid incorrectly.   

Solutions:

The good news is that changes to the process could prevent this issue from occurring. The simplest solution would be to create estimates in QuickBooks rather than invoices. Then once the final product is delivered, convert the estimates into invoices. In the conversion process, edits can be made based on what was actually delivered. This way, the customer and the company will have matching records regarding the invoice. 

All of these changes flow from the principle that, unless payment is being collected upfront, invoice should be created upon delivery of a completed product or service, and not before. There is one exception to this rule however, wherein a customer pays for part of a product or service, rather than pay for everything at once. This is called progress invoicing, and we’ll be discussing this in a future blog.

Looking Forward: 

For now, we are ready to move on from Stages 1 and 2 and look at the next two stages: collections and receiving payments. Next time on Bookkeeping Horror Stories, I’ll be sharing my tips on collecting from customers and avoiding a ballooning of old AR in your balance sheet. Be sure to check in at the end of the month for part 2, and in the meantime you can contact me to discuss your own small business bookkeeping situation by clicking here.