Accounts Receivable (A/R) is the amount of money due and payable by customers for the goods and services sold by the company. This balance is usually reflected in the balance sheet as current assets because it is likely to be returned within a short period, preferably within the 30 to 90 days period.
Accounts receivable are any amount of money that is invoiced to a customer for a product or service, and even if the payment has not been made, it is still considered accounts receivable. The amount and the period can be influenced by other factors, such as the payment terms you set in your contract, such as discounts for early payment or penalties for late payment.
Key Takeaways
Important Notes for Accounts Receivable
Accounts Receivable Drive Cash Flow
Timely collection of outstanding invoices from customers is essential for steady cash flow. This steady stream of cash helps pay bills, run the business day-to-day, and invest in growth.
Good AR Management Means More Available Cash
When a company stays on top of who owes them money, they have an easier time accessing funds when needed. This leads to stronger financial stability.
New Companies Often Struggle to Get Paid
Startups might have to wait longer to receive payments at first. They need time to set up payment terms with new customers. This can get better as the company grows.
Monitor Receivables Turnover
Companies should check how they turn unpaid bills into cash. This helps spot trends and fix problems before they threaten the business.
Lots of Late Payments Can Mean Trouble
If customers always pay late, it might point to bigger issues. Your company could have money problems, or your clients might not be able to pay their bills. You need to act fast to fix these delays.
Types of Accounts Receivable
The accounts receivable classifications can be specific to certain clients or differentiated by the types of products or services. Some organizations also distinguish accounts receivable based on whether the promise to pay was oral or written. Accounts receivable belong to the larger group of receivables, which include notes receivable and others such as rent receivables, loans, term deposits, and many others. Indeed, there are countless types of receivables that will account for almost every industry and distinct circumstances.
Notes receivable are the amount that a customer is legally bound to pay back after signing a formal promissory note indicating the loan amount owed.
Companies in the housing or commercial estate industry monitor rents receivable, which is money that the tenant owes, usually every month.
Any loans made to such persons as employees or other related companies lead to the formation of loan receivables.
If you have a financial interest in your business, and if anybody owes such interest on an installment, your accountant would note that amount as ‘interest receivable’.
How to Record Accounts Receivable
Accounts receivable appear as current assets on the balance sheet and as a sale or generation of revenue on the income statement, just like cash, inventory, and other products or services that were purchased. Some accounting software will automatically compute accounts receivable as the user creates client invoices.
Account receivables are recorded in accrual accounting since funds that have been earned but not collected are called accruals. In cash accounting, the transaction would not be recorded in the accounts until the client paid.
Accounts Receivable vs. Accounts Payable
Accounts payable is what some companies owe their suppliers or some other parties in a business scenario. Accounts payable are obligations for products and services to suppliers, which are the opposite of accounts receivable. For instance, Company A is in charge of cleaning Company B’s carpets and sends a bill for the service.
Company B owes money to Company B, so it records the invoice in its accounts payable column. Company A is still expecting the money; therefore, it appears in the accounts receivable section.
What Accounts Receivable Can Tell You
Accounts receivable are one of the key indicators of a company’s fundamental performance analysis. Accounts receivable are included under the current assets, thereby representing a measure of a business’s liquidity or its capacity to meet short-term obligations without additional cash flows.
The accounts receivable can be established in the context of turnover, also known as the accounts receivable turnover ratio, which defines how many times during an accounting period the balance has been collected.
Further analysis would include assessing the Days Sales Outstanding (DSO), which would represent the number of days it takes to be paid after making a sale.
Accounts Receivable Process
In its simplest terms, accounts receivable begins with a procedure that is initiated from the time a client and a seller agree on a purchase and payment plan. Subsequently, an invoice is issued, and the account receivable is created.
If the account is paid as agreed, then it is recorded as a deposit and no longer on the balance sheet as a receivable. When the account is not paid as agreed, the firm initiates a collection process.
What is the Accounts Receivable Turnover Ratio?
The accounts receivable turnover is calculated by dividing the net credit sales for a given period by the average accounts receivable. The AR turnover ratio determines the company’s ability to extend and collect credit from its clients. A high turnover ratio means a business is more conservative in extending credit or more aggressive in collections.
This ratio can be used with an allowance account or an allowance for doubtful accounts, which presents the percentage of the accounts receivable that are likely to be received in the future cash flow. An allowance account, or an allowance for doubtful accounts, is a contra-asset account that decreases the value of the actual asset in the general ledger to specify the amount of money the business examines to collect.
While the AR/AP ratio depicts a company’s sales picture, the accounts receivable turnover ratio shows the efficiency of collection. A perfect AR/AP means that your company is making sales to meet the necessary expenses, even if some of the clients delay payment or even fail to pay at all. Thus, a higher AR turnover ratio reveals that your business effectively manages the receivables and has excellent credit collection from all the invoices.
In other words, accounts receivable is the record of money that a customer owes to the business for the services or goods that have already been delivered. Weaknesses in the record maintaining in accounts receivable may cause problems in audits, and misconceptions of cash flow may lead to wrong business decisions. Nonetheless, with accurate methods of invoicing and accounting, you will have a good understanding of your business’s financial health for the formulation of your business strategy, funding, or persuading potential investors.
Example of Accounts Receivable
For example, imagine there is an electronics retailer company in Hong Kong named “HK Gadgets Ltd. “ They sell a consignment of smartphones to a local store on credit. HK Gadgets issues an invoice for Tech Store 100,000, which is payable after 30 days. This amount is then reported on their balance sheet as accounts receivable. In turn, the company intends to receive this payment within the stipulated period, which will ensure adequate cash flow and business operations.
Therefore, A/R is one of the critical factors of success, and through proper management of account receivables, companies can have the opportunity to collect money on time, improve cash flow, and avoid cases of bad debt.