Joseph Varughese, Emagia Senior Contributor
31st January, 2025
Introduction
For CFOs, treasurers, and finance leaders, effective cash flow management is critical to maintaining financial stability. At the core of this effort is the optimization of accounts receivable (AR) collections, ensuring that outstanding payments are collected efficiently and on time.
The AR collection process typically involves invoicing, statement issuance, payment follow-ups, and cash application. However, many organizations struggle with weak collection processes, often due to inadequate reporting mechanisms that obscure which receivables are collectible, which are at risk of delay, and which are likely to default.
Leading finance organizations continuously refine their AR strategies, adopting best practices and digital solutions to accelerate collections and enhance efficiency. According to J.P. Morgan, optimizing AR strategies—whether through technology adoption, process automation, or scalable methodologies—is essential to improving days sales outstanding (DSO) and the cash conversion cycle, particularly in times of economic uncertainty.
Different industries can face different challenges along the way. For example, for manufacturing companies, managing accounts receivable effectively can be more complex due to an extended cash conversion cycle. Manufacturing businesses must invest in raw materials, convert them into finished goods, sell them, and then wait for customer payments—creating a long lag between expenditure and revenue realization.
A lengthy cycle, for whatever reason, introduces several challenges:
- Delayed payments due to long production and delivery lead times.
- Cash flow volatility, which can disrupt supply chain operations.
- Strained customer relationships due to payment disputes or process inefficiencies.
To mitigate these risks and more, businesses are increasingly turning to AI-driven receivables management solutions that automate cash application, collections, and dispute resolution, reducing manual workload and enhancing real-time financial visibility.
Eight Best Practices for AR Collections
A well-structured collections strategy can expedite cash inflows, strengthen working capital management, and reduce bad debt exposure. Below are eight best practices that leading enterprises implement to enhance AR collections and mitigate financial risk.
1. Establish a Robust Credit Policy
One of the primary drivers of collection inefficiencies is a lack of clear credit policies. Organizations must:
- Define transparent credit terms, including payment deadlines, late payment penalties, and early payment incentives.
- Regularly assess customer creditworthiness using real-time data analytics.
- Align credit policies with the company’s cash conversion cycle and risk tolerance.
- Implement AI-driven credit assessment tools to dynamically adjust credit limits and mitigate risk exposure.
2. Optimize Invoicing Processes
Delayed or inaccurate invoicing is a major cause of late payments. Best practices include:
- Automating invoice generation and transmission via ERP systems or digital invoicing platforms.
- Ensuring invoices include purchase order references, tax details, payment instructions, and clear due dates.
- Proactive follow-ups on outstanding invoices before they become overdue.
- Leveraging customer self-service portals to reduce disputes and enhance payment transparency.
3. Expand Payment Options for Customers
Providing flexible payment methods improves the likelihood of on-time payments. Best practices include:
- Supporting bank transfers, ACH, credit/debit cards, and digital wallets.
- Encouraging online payments, which increase collection efficiency by up to 30%.
- Offering automated recurring payments for high-frequency transactions.
- Utilizing customer portals for real-time payment tracking and dispute resolution.
4. Establish Benchmarks and KPIs
Consistently measuring AR performance enables continuous process improvement. Key AR collection metrics include:
- Days Sales Outstanding (DSO): Measures the average time it takes to collect receivables.
- Average Days Delinquent (ADD): Identifies payment delays beyond due dates.
- Collection Effectiveness Index (CEI): Evaluates the efficiency of collection efforts.
- AR Aging Reports: Categorize outstanding receivables by age to prioritize collection efforts.
5. Prioritize Collections and Follow-Ups
Not all overdue accounts require the same level of attention. High-risk accounts should be prioritized using:
- Automated segmentation of accounts based on risk scores and payment history.
- Predictive analytics to anticipate potential defaults.
- Customizable dunning strategies that adjust follow-up frequency and messaging based on risk levels.
6. Strengthen Dispute Management Processes
Payment disputes are a primary reason for delayed collections. To reduce disputes:
- Ensure invoice accuracy to minimize errors.
- Use AI-driven dispute resolution tools to track and resolve disputes in real-time.
- Facilitate collaborative resolution via customer portals, enabling customers to dispute charges digitally and finance teams to address them promptly.
7. Maintain Strong Customer Relationships
While collections must be firm, relationship management is equally crucial to ensuring long-term financial success. Strategies include:
- Proactively identifying and addressing potential friction points before they escalate.
- Implementing customer satisfaction surveys to gauge AR service quality.
- Maintaining regular engagement through automated reminders and personalized communications.
8. Leverage AI and Automation
Modern AR automation platforms significantly enhance collections by:
- Accelerating invoicing and cash application through AI-driven processing.
- Automating follow-ups and reminders based on customer payment patterns.
- Enhancing credit risk assessment with predictive analytics.
- Providing real-time insights into collections performance via dashboards and reporting tools.
Advanced AR automation solutions—such as Emagia’s AI-powered collections platform—integrate seamlessly with ERP systems like Oracle, SAP, and Microsoft Dynamics, enabling finance teams to optimize workflows and reduce manual intervention.
Conclusion
In today’s rapidly evolving business landscape, manual AR processes are no longer sustainable. Despite recognizing collections as a critical revenue function, fewer than 30% of companies have adopted AR automation, according to industry research. Resistance to change and lack of internal alignment remain the most cited barriers.
However, companies that embrace AI-driven AR automation can achieve:
- Faster collections and improved cash flow.
- Reduced operational costs through streamlined workflows.
- Greater financial visibility with real-time performance tracking.
By implementing these eight best practices, finance leaders can transform AR collections from a reactive function into a strategic, value-driven process.
FAQs
Days Sales Outstanding (DSO): Measures how quickly receivables are converted into cash.
Collection Effectiveness Index (CEI): Assesses how much of the total receivables were collected in a given period.
Accounts Receivable Turnover Ratio: Indicates how efficiently receivables are managed.
Bad Debt to Sales Ratio: Measures the percentage of revenue lost due to uncollectible accounts.
