What is Accounts Receivable?
Definition: Accounts Receivable is defined as the pending bills or money that customers or clients owe to a company. It is the outstanding invoices or the money that the customers have not paid yet. The accounts receivable is generally in the form of invoices raised by a business and delivered to the customer for payment.
Accounts Receivable is the amount that is due to the firm for the goods or services that the company already delivers, but the company is not yet paid for the same. Accounts Receivable are mentioned on the assets side of the balance sheet and comes under the head of current assets.
Accounts receivables come into practice when a company lets a buyer purchase their goods or services on credit sales. In simple words, account receivable is the money that you as a business owner have the right to receive because you have provided some goods or services but you have not received that money yet.
It represents the line of credit extended by the company within a short period. When a company sells to the customer on a credit basis, it usually extends a period to the customers for paying the amount. The turnover ratio of the accounts receivable or the day’s sales outstanding can provide information about the company’s strength.
The accounts receivable team is responsible for receiving the funds from the debtors on behalf of the company and making the changes in this account as soon as they receive payment from any debtor. The collection and cashiering teams are part of the account receivable department.
The collection department has to seek the debtors, and the cashiering team has to apply the money received. Accounts Receivable also has an impact on the liquidity of the business. Thus, a company needs to pay attention to these metrics as well.
Account Receivable Terms
Some of the common terms that are used in the accounts receivable process are-
1. Accounts receivable turnover ratio
The accounts receivable turnover ratio can be defined as a basic financial calculation that helps businesses to gauge how fast their customers are at paying the money that they owe. You can calculate it by dividing total net sales by average accounts receivable.
2. Accounts receivable aging schedule
Businesses opt for this method for tracking who is behind which payment at the time when the business has a huge customer base.
3. Average Collection Period
It can be understood as the amount of time that a business would take to receive payment from customers and clients.
4. Current Liabilities
It talks about the obligations and debts of a business that are owed to creditors.
Process of Accounts Receivable
Some of the common steps that businesses take during this process are-
- Invoice their customers on credit based upon the credit policy. Some of the key information that should be included in this are- Correct date, Customer information, Services provided, Amount due, Due date, Relevant purchase order info if your customer provided you with it, Your contact data, Payment terms.
- Capture or record the due date or credit days and then follow up with a collection schedule
- Generation of the overdue bills and the ones that are pending for the longest time
- Send a reminder letter that incorporated the details of bills that are pending
- On receiving payment, accounting the receipt and adjusting the receivables accordingly
- In case of any cash discount for the early payment, there should be a relevant adjustment to the receivables account
Payment Terms for the Accounts Receivable
The typical payment term in the accounts receivable is of net 30 days; this means that the payment is due at the end of 30 days from the date of the invoice. However, the debtor is free to pay the due amount before the completion of 30 days. For this advance payment, the company can provide discounts.
The other net payment days include 45 days and 60 days. If a debtor makes a late payment, then the company can charge interest or late fees on the due amount.
Bookkeeping of Accounts Receivable
Accounts Receivable are classified under the sub-head, “current assets”. Here, it is assumed that they are due within one financial or calendar year. In the double-entry bookkeeping system, it is necessary to have the dual effect of a transaction on the company.
To record the Accounts Receivable in the double-entry system, the Accounts Receivable is debited while the revenue account is credited. When a customer pays off this debt, the accountant of the company will reverse this entry. So, the Accounts Receivable will be credited in the new journal entry, and the cash account will be debited. While making a trial balance sheet at the end of the financial year, this account generally shows a debit.
Most companies have adopted accounting software to perform these entries on the computer in today’s time. To measure the accounts receivable’s net value, there are two methods available that a company may use. The first method is the allowance method, while the second method is the direct write-off method.
1. Allowance Method
In the allowance method, a contra asset account is created. These accounts can be the allowance for doubtful accounts or bad debt provision. These accounts have the effect of reducing the balance for accounts receivable. It can be calculated either using the income method or the balance sheet approach.
2. Direct Write-Off Method
In the direct write-off method, a single entry is made to reduce the accounts receivable to its net realizable value. In this method, the bad debt expense account is debited, and the accounts receivable is credited. But this method is not permissible under the Generally Accepted Accounting Principles.
However, when it becomes clear that the accounts receivable won’t get paid by a debtor, then it is necessary to write them off. Here, the accounts receivable are written off as a bad debt expense or one-time charge.
Accounts Receivable vs Accounts Payable
Accounts Receivable is the amount that is outstanding with the customers in exchange for the goods or services purchased from the company on credit. While on the other side, accounts payable is the opposite of accounts receivable. Accounts payable is the amount that company owes to its suppliers or other parties.
For instance, suppose company A provides the service of carpet cleaning to Company B, and it sends the invoice to Company B. So, here Company A will record this invoice as the accounts receivable while Company B will record it as the accounts payable.
Advantages of Accounts Receivable
The advantage of accounts receivable is that it helps in various types of analysis, and it is used by many financial analysts to make some analysis about the company.
Accounts Receivable is the current asset of the company. So, it measures and shows the liquidity and ability of the company to cover the short-term loans and obligations without additional cash flows. Most of the fundamental analysts use the accounts receivable to determine the turnover and to calculate the accounts receivable turnover ratio.
The accounts receivable turnover ratio measures the number of times a company has collected its accounts receivable amount during the financial year.
Another analysis that can be made through the use of accounts receivable is days sales outstanding analysis. This analysis measures the average collection period for a company’s receivables balance over the accounting period.
Notable uses of Accounts Receivable
Accounts Receivables are used by companies in many cases. A company can use accounts receivables in the following ways:
1. Collateral while obtaining a loan
2. Sell them for factoring or on an exchange
3. Portfolios of accounts receivable can be sold to third parties through securitization
4. Tax reporting purposes
In taxation, the general provision for bad debts is not allowed for deducting it from profit. But a business can get relief for that specific debtor who has gone bad. However, the companies choose a general provision for the bad debts. It is done to avoid the overstating of the debtors in the balance sheet.
Tips to Manage Accounts Receivables
Some of the best tips that will help you learn how to manage accounts receivable are-
- Have a clean track of bills
- Have a close eye on long-pending bills
- Check payment performance of your customer
- Incorporate a collection schedule and following up
- Use internal credit control techniques
- Opt for accounting software to manage accounts receivables
- Have a crystal clear credit policy to make people pay faster
- Offer customers a financial incentive to pay faster
- Call your customers and schedule regular reminders
What to do if Customers don’t Pay?
In case you have tried all the aforementioned tips but still, your customers are not paying their dues then you may try the below-given practices-
- Cut late-paying customers off
- Convert their account receivable into a long-term note
- Hire a collection agency after giving your customers one last chance to make their payments
Now you know what accounts receivable is, how you can manage it efficiently and how it will enable you to manage healthier cash flow.
Though it is money that customers or clients owe, it is convertible to cash in the future which makes it an asset for a business, and a balance sheet lists it among current assets. However, if you wait more than one year to convert it into cash, it can be termed as a long-term asset.
Finally, after clearing every single concept of accounts receivables on the goods and services offered by a business, we would like to see your definition of accounts receivable in the comments below.