How to manage accounts receivable and accounts payable for better cash flow

For SaaS founders, managing cash flow is like keeping a car running toward its destination. Cash is the fuel that keeps businesses operating and ready for growth. Without a steady, reliable cash flow, SaaS companies will struggle to cover their expenses.

In subscription-based SaaS businesses, cash flow is greatly influenced by the efficiency of accounts receivables (AR) and accounts payables (AP). Effective AR management ensures timely payment collection, maintaining steady cash inflow. Similarly, timely AP settlement is crucial for good supplier relationships and avoiding late fees or service disruptions.

Delays in AR collections or early AP payments can disrupt cash flow. By optimizing AR and AP processes, SaaS businesses can maintain the liquidity needed to operate and invest in growth.

This article offers early-stage SaaS companies a clear understanding of how AR and AP affect cash flow. It provides key metrics to monitor cash flow and shares best practices for optimizing AR and AP management to support business growth and sustainability.

Why AR is important for SaaS businesses to manage effectively

Accounts receivable (AR) refers to the amount a company owes for services delivered but still needs to be paid for by customers. AR is listed as a current asset on the balance sheet because it’s expected to convert to cash within a year.

For SaaS businesses, accounts receivable typically arise from subscription-based pricing models where customers are billed upfront or periodically for ongoing services. 

Let's say your SaaS company sells a subscription for $30,000 annually, split into $15,000 for software licenses and $15,000 for customer success support. Upon issuing an invoice, the following entries will appear in your general ledger:

• Debit Accounts Receivable: $30,000 (amount owed by the customer)
• Credit Revenue: $15,000 (recognized revenue for software licenses)
• Credit Deferred Revenue: $15,000 (unearned income for customer support, to be recognized over the service period)

AR impacts your SaaS company's liquidity as it relies on recurring revenue. Efficient collection shortens the cash conversion cycle, freeing funds for reinvestment in marketing, product development, or hiring. Delayed payments can strain cash flow and hinder growth opportunities. A well-managed AR is important for SaaS businesses as it creates a healthier financial position for the company and boosts investor confidence.

However, AR management isn't just about tracking invoices and collections. Let's discuss the steps to optimize the AR process and how AR aging affects cash flow forecasting. Understanding the key AR metrics SaaS businesses should track to monitor AR will help avoid cash flow pitfalls.

Understanding the AR process and management for positive cash flow

For SaaS companies, poor AR practices can cause bottlenecks and create risks for day-to-day operations. According to Sage, poor accounts receivable management results in up to 10% losses in revenue for SaaS companies. The revenue leakage comes from delayed payments, incorrect invoicing, and lack of follow-up. This makes it essential to optimize AR practices.

Key steps in the AR process

To improve the AR management of your SaaS business, let's take a look at the key steps in the AR process:

1. Sending out accurate invoices

The AR process begins with creating and delivering invoices to customers promptly. Often, late payments are the result of billing errors. SaaS companies struggle with invoice accuracy due to diverse and often complex pricing models like subscriptions, usage-based charges, and promotions. Billing errors can confuse your customers and finance teams. A failed payment due to an invoice error may lead to involuntary customer churn, which further impacts cash flow.

2. Managing collections

Having a well-structured process with consistent timelines for following up on unpaid invoices can significantly improve cash flow. According to PYMTS, firms that follow up on unpaid invoices within five days typically have around 9% overdue receivables whereas those that wait until 45 days have passed have much higher number, close to 26% overdue receivables. While it’s clearly beneficial to send timely reminders and follow up regularly, it’s also important to establish clear payment terms and penalties for late payments. For customers with recurring payments, offering flexible payment terms can improve collection efficiency.

3. Processing payments

According to one estimate, failed payments and involuntary churn costs SaaS companies about 9% of their MRR. Dunning management, a process that helps companies prevent revenue leakage and reduce Days Sales Outstanding (DSO). It’s also important to accelerate payment collection by providing customers with multiple payment options such as credit cards, ACH, wire transfers, or digital wallets. Use payment gateways that provide real-time updates on payment failure and retry payments automatically.

‍4. Posting transactions to internal systems

After payments are received, they must be accurately recorded in your company's ERP or FP&A systems. This includes posting payments to the appropriate accounts, updating customer records, and reconciling with bank statements. Automating AR reconciliation reduces errors and saves time for your accounting team. Leveraging a centralized system for recording transactions allows for better visibility into revenue, collections, and outstanding balances.

Impact of AR aging on cash flow forecasting

Accounts receivable aging sorts overdue invoices by their pendency duration, amounts, and likelihood of collection. AR aging directly impacts cash flow forecasting by revealing how customer payment behaviors align with cash inflows. 

Analyzing your AR aging gives you other key insights in addition to customer payment behaviors. With AR aging reports from your ERP or accounting system, you can better assess the health of your cash flow by estimating doubtful accounts and identifying potential bad debts to make more informed cash flow decisions. Let’s take a closer look at what you can learn from an AR aging report:

• Identify payment patterns: By analyzing historical payment trends like Net-30 or Net-60 terms, businesses can predict when payments will arrive. If a customer consistently pays 15 days late after Net-30 terms, the delay should be included in cash flow projections. 
• Improve revenue forecasting: AR aging helps businesses segment customers by payment behavior, which can be included in revenue forecasts. Customers with longer payment delays can be accounted for separately, allowing for more accurate cash flow predictions.
• Spot early warning signs: An increasing AR aging metric signals payment delays that may lead to liquidity issues. Businesses can use this information to prioritize collections, identify high-risk accounts and accounts for which they may need to adjust credit terms, and create a provision for bad debts. 

AR aging reports also help in estimating doubtful debts, which are invoices that are likely to become uncollectable). Estimating the amount such invoices allows you to better account for them in financial statements with what is known as a “provision for doubtful debt”. Longer-outstanding invoices carry a higher risk of becoming bad debt (invoices that are confirmed as uncollectable). Factoring in doubtful debts prevents overestimating available cash. 

Writing off those that become bad debts ensures the balance sheet accurately reflects current accounts. You can use one of two methods to write off bad debts: 

1. Direct write-off method: Remove the specific amount from accounts receivable and record it as an expense. if a debt is deemed uncollectible.
2. Allowance method: Create a provision for doubtful debts upfront, and adjust accounts periodically based on an aging analysis and historical data.

Key AR metrics to track for SaaS businesses

Tracking the right metrics helps monitor cash flow accurately and optimize AR management. Here are some key AR metrics SaaS businesses should track:

Days sales outstanding (DSO)

‍DSO measures the average days a company takes to collect payment after a sale, showing the efficiency of its collection process. A high DSO suggests cash flow issues, indicating delayed payment collections that can impact operations. A low DSO points to efficient collections and better cash flow management. Monitoring DSO isn't essential for SaaS companies as customers know access can be revoked if they don't pay on time. DSO for SaaS businesses is around 30 days.

Best possible days outstanding

‍Best possible days outstanding is a metric representing the ideal number of days a company aims to collect receivables. It is based on industry standards or internal benchmarks. Comparing it with actual DSO helps set realistic goals for collection.

Accounts receivable turnover ratio

‍The accounts receivable turnover ratio measures how many times a company collects its average accounts receivable during a specific period. A higher turnover ratio indicates efficient collection processes, while a lower ratio may suggest issues with credit policies or customer payment behaviors. SaaS companies use the metric to assess their credit sales and collections management.

Average days delinquent (ADD)‍

Average days delinquent measures how many days invoices are overdue on average. It is calculated by analyzing accounts receivable aging and determining how long invoices go unpaid. Monitoring ADD offers insights into customer payment behaviors and highlights potential issues with clients or segments. A rising ADD indicates worsening customer relationships or ineffective collection strategies.

Bad debts to sales ratio

‍The bad debts to sales ratio measures the proportion of uncollectible accounts relative to total sales. A higher ratio shows that a large share of sales isn’t being collected, which reduces profitability and disrupts cash flow. SaaS companies can use this metric to evaluate and adjust their credit policies to minimize bad debts.

Collections effectiveness Index (CEI)

‍The CEI measures the company’s outstanding receivables collection over a specific period. A high CEI indicates strong collection performance, while a low CEI suggests issues needing attention.

Operational cost per collection

‍Operational cost per collection measures the total operational costs associated with collecting payments divided by the total successful collections in a period. SaaS businesses can use this metric to manage AR process expenses. High costs signal inefficiencies in the collection process which, if corrected, can improve profitability.

Why good AP management is equally important

Accounts payable (AP) are the outstanding obligations a company owes to suppliers or vendors for goods and services bought on credit.

The sum of all AP is listed as a current liability on the balance sheet and is considered a short-term debt due within a year. 

For example, if your SaaS business buys $500 worth of office supplies from Staples on credit. You would record the transaction in your accounting system by debiting the Office Supplies account and crediting the Accounts Payable account. Once payment is made, you would then debit the AP account and credit the cash account to clear the liability.

In addition to clearly understanding your short term liabilities, looking at your data on your company’s spending patterns, vendor performance, and how those impact your cash flow can also help improve forecasting and budgeting, negotiate better payment terms with vendors, and make more informed operational decisions.

Understanding the AP process and AP management for better  cash flow

A well-structured AP process enhances cash flow, strengthens vendor relationships, and supports overall business efficiency. Let's take a closer look at the accounts payable cycle:

1. Purchase order (PO) creation and approval: The AP process starts with creating a PO, which is reviewed and approved to ensure expenditures align with the budget. The document outlines the specific goods or services required, their quantities, agreed prices, and other terms. It prevents unauthorized spending and sets clear expectations with vendors, ensuring accuracy.
2. ‍Goods receipt and invoice matching: Upon delivery of goods or services, the company generates a receipt or acknowledgment of delivery. It confirms the items received match the order. The AP team then performs a three-way match between the purchase order, goods receipt, and vendor invoice to verify pricing and quantities. It eliminates discrepancies and prevents errors.
3. Invoice verification and approval: After matching, the invoice is reviewed to spot inconsistencies like wrong vendor details, invoice number, date, item descriptions, quantities, prices, and taxes. Any issues are resolved before approval from relevant departments. Verifying invoices upfront prevents overpayments, duplicate payments, and vendor disputes.
4. Invoice recording and payment authorization: Once approved, invoices are entered into the company's accounting system and categorized with the correct general ledger codes. It ensures liabilities are accurately reflected in financial statements. The system logs the invoice, matches it to the correct accounts, and schedules payments based on payment terms like early payment discounts. Accurate recording ensures compliance with financial reporting standards and provides a clear view of liabilities.
5. Payment processing and reconciliation: Payments are made according to the agreed terms using methods like electronic transfers, checks, ACH, or credit cards. After payment, the AP team reconciles transactions with invoices to maintain accurate financial records for cash flow management. Payment confirmation is logged, ensuring company records align with the vendor's accounts. Timely, accurate payments build trust with vendors and prevent late fees.

AP management helps SaaS businesses avoid cash crunches by balancing outgoing payments and incoming revenue. Poorly managed AP can cause overdue payments, strained vendor relationships, or penalties whereas a streamlined AP process offers stable payments and builds supplier trust. 

Key AP metrics to track for SaaS businesses 

Here are some key AP metrics SaaS businesses should track:

AP turnover ratio

‍The AP turnover ratio, or creditor's turnover ratio, is a key liquidity metric. It measures how efficiently a company pays its creditors. It shows how often a company pays its suppliers during an accounting period, helping evaluate short-term liquidity. A higher accounts payable turnover ratio shows a company is settling debts more often, indicating strong liquidity and prompt financial management. 

‍Days payable outstanding (DPO)

‍Days payable outstanding is a key metric indicating the average number of days a company requires to settle its accounts payable. It helps businesses assess how well they manage vendor payments. A low DPO indicates quick payments and can help them secure discounts or better terms. A high DPO means the company takes longer to pay. It may conserve cash flow but possibly strain supplier relationships.

‍Average cost to process an invoice (AP cost)‍

AP cost measures the expenses of handling each invoice a company receives. It includes labor costs associated with managing and paying vendor invoices, as well as technology and software expenses used in the AP process. Overhead costs such as utilities and supplies for invoice processing are also included. Tracking AP cost helps businesses spot inefficiencies, identify cost-saving opportunities, and allocate resources more effectively.  AP cost is the total operational costs associated with collecting payments divided by the total successful collections in a period.

‍Average invoice processing cycle time‍

This metric reflects the average time in days that it takes to process an invoice, from the date it is received to the date it is paid. A shorter cycle time means faster payments, improved supplier relationships, and the possibility of earning early payment discounts. 

The relationship between AR and AP and how they impact cash flow stability

Stable cash flow is key to covering expenses, funding growth, repaying debt, and creating stakeholder value. Keeping a good balance between AR and AP helps to maintain cash flow stability. 

Cash flow and its relationship to AR and AP

Stable cash flow is key to covering expenses, funding growth, repaying debt, and creating stakeholder value. Keeping a good balance between AR and AP helps to maintain cash flow stability. This makes sense when you consider what cash flow is and what AR and AP each represents: 

• Cash flow: Cash flow is simply the inflow and outflow of cash in your business. AR collections represent money coming into the business, while AP is the money flowing out of the business to suppliers and creditors. Cash is the amount of money immediately available for use in the business. 
• AR has an inverse relationship with cash flow: AR represents money that will flow into the business at some point in the future. Increases in AR can have the effect of delaying cash inflow in the short term. This reduces the cash available to the business, limiting its ability to reinvest, pay debts, and grow. 
• AP has a positive relationship with cash flow: AP, if managed well, can help balance out the impact of AR on cash flow, giving businesses a cushion by delaying cash outflow. 

Accounts receivable vs. accounts payables

AR and AP have different effects on cash flow, which can be effectively managed by tracking financial movements, handling operations, and assessing upcoming obligations. 

For example, AP can also be used strategically to negotiate longer payment timelines with suppliers to free up cash for short-term needs. At the same time, ensuring the creditworthiness of customers and implementing robust billing practices can speed up AR turnover to improve cash inflow and strengthen the company's financial position.

The table below provides a comparison between AR and AP and their different impacts of cash flow differently:

Common cash flow issues in AR and AP management

There are several challenges that companies might encounter in managing their cash flow. Below, we’ll discuss some of the most common along with ways to overcome them. 

Challenges in managing accounts receivable

Common pitfalls businesses encounter in managing AR include: 

• Delayed invoicing: Delays in invoicing disrupt cash flow by postponing payments. Companies should send invoices promptly after delivering goods or services to maintain a steady cash inflow. In the context of SaaS, this isn’t an issue for companies that have automated payments tied to a customer’s credit card. However, delays in invoicing can impact companies that invoice annually for a monthly subscription. 
• High days sales outstanding (DSO): A high DSO means a company takes longer to collect customer payments, which hurts cash flow by tying up funds and limiting the ability to invest, pay bills, or cover operational costs. This is typically less of a problem for SaaS companies because customer access to the product is usually cut off if payment isn’t received within a certain timeframe. 
• Ineffective follow-ups: Without regular follow-ups on invoices, businesses risk payment delays. Clear communication helps remind customers about due payments and address any issues with payment. In SaaS where many companies automatically collect payments via credit cards, follow-up on missed payments should happen as quickly as possible as they can lead to involuntary churn (in the case of a customer’s credit card expiration) or signal an issue with the company’s payment processor.  
• ‍Manual processes: Manual AR processes often cause inefficiencies, errors, and delays. Automating AR is key to streamlining operations, reducing errors, and ensuring invoices are processed correctly and on time.

Challenges in managing accounts payable

Some of the most common pitfalls in managing AP include: 

• Early payments without discounts: Settling debts quickly might seem helpful, but it uses cash needed for investments or other expenses. Companies should review payment terms and negotiate early payment discounts to optimize cash flow.
• Missed payment deadlines: Missing payment deadlines can result in late fees, strain a company’s vendor relationships, and damage its credit rating. Using accounting software to automate payments and trigger reminders helps ensure timely payments.
• ‍Neglecting vendor negotiations: Not negotiating with vendors for favorable payment terms like extended deadlines or early payment discounts is a missed opportunity to improve cash flow. Regularly discuss terms and amend agreements where possible to support good cash management.
• Lack of data for cash flow visibility: Without good data to monitor cash flow, companies may overspend, leading to shortfalls, and miss out on strategic investment opportunities. Accurate and real-time data helps spot trends and predict needs to improve cash flow management.

Best practices to optimize your AR and AP management

Effective management of AR and AP can help SaaS businesses avoid financial stress. Here are key best practices to optimize your AR and AP management:

1. Understand current cash flow patterns

‍Analyze AR and AP data to identify patterns like late payments, peak cash inflows, and mismatches between receivables and payables. Use these insights to predict cash flow gaps and adjust payment strategies. 

2. Establish clear payment terms for AR and AP

Balance AR and AP by setting clear payment terms.

• For AR: Define clear payment terms with late payment penalties and early payment discounts like 2% for payments received in 10 days or less on accounts with Net 30 payment terms. Always communicate payment terms during onboarding and on every invoice. 
• For AP: Negotiate extended payment terms with suppliers to better balance your cash outflow with inflow. This will reduce cash strain while maintaining strong relationships.

3. Automate AR and AP processes‍

Invest in financial management tools to automate and simplify invoice generation, payment tracking, and reminders, reducing overdue balances. Automate payments to vendors, too, for timely and error-free transactions. Cash flow forecasting software that combines AR and AP data can help you make more data-driven decisions while preventing human errors such as double payments, missed invoices, or mismatched entries.

4. Create and monitor aging reports

‍Generate AR aging reports regularly to track overdue balances and prioritize collections based on delinquency length. Monitor AP aging reports to meet supplier obligations on time. You can also use these reports to spot issues like late-paying customers or inflexible suppliers.

5. Align AR collections with AP obligations

‍Schedule payables to match receivables, to ensure your cash inflows are sufficient to cover your cash outflows. Prioritize collecting larger or older receivables before major AP deadlines.

6. Communicate transparently with customers and vendors‍

Resolve disputes with customers quickly and send reminders before due dates to encourage prompt payments. Also confirm payment schedules with vendors and adhere to their payment terms to avoid supply disruptions or penalties.

7. Regularly review cash flow

‍Review cash flow on a monthly basis at minimum and weekly if possible. This will help you adjust AR and AP strategies more quickly, possibly in real-time if you’re leveraging technology to help you manage your cash flow. Reviewing key data such as customer behavior data along with supplier policies, can help you update forecasts proactively and prepare for sudden changes in your business, market shifts, or seasonal demands.

8. Maintain a cash buffer

‍Always try to keep some cash on hand to handle unexpected AR delays or AP demands. A cash buffer gives flexibility and helps manage short-term liquidity issues without needing external funding.

Avoid cash flow problems: Use an FP&A tool to improve your AR and AP management

SaaS businesses need to streamline AR and AP processes to maintain cash flow and smooth operations. Modern financial planning and analysis (FP&A) tools can help SaaS companies avoid cash flow issues in several ways. 

One of the biggest advantages of FP&A tools is their ability to integrate with a company’s ERP system or accounting software, which streamlines AR and AP processes by minimizing (or completely eliminating) manual data consolidation and associated human error. 

You also need a solid cash flow forecasting software to help inform your spending and other decisions that can impact cash flow. A robust FP&A platform will provide this capability and much more.  

Drivetrain is a comprehensive FP&A platform with features to support and enhance all the financial operations in your business, including cash flow forecasting and other financial forecasting capabilities. And here are just a few of the ways that Drivetrain can help you better manage your AP and AR processes:

• Automate data consolidation: Drivetrain offers native 200+ integrations, including some of the most popular ERP/accounting systems as well as custom integrations if needed, for real-time data consolidation and access. 
• Calculate custom metrics to track performance of your AR and AP processes so you can easily see what’s working and what isn’t. 
• Generate key financial statements, such as P&L statements, balance sheets, and cash flow statements in real-time to help identify trends and variances that could affect cash flow.

Ready to say goodbye to cash flow woes? Contact Drivetrain for a demo today!