Accounts receivable (AR) represent the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. It is listed on the balance sheet as a current asset and encompasses any money owed by customers for purchases made on credit.
Key Takeaways
- Accounts receivable (AR) is an asset account on the balance sheet representing money due to a company in the short term.
- AR is created when a company lets a buyer purchase their goods or services on credit.
- Accounts payable is similar to accounts receivable, but instead of money to be received, it is money owed.
- The strength of a company’s AR can be analyzed with the accounts receivable turnover ratio or days sales outstanding (DSO).
- A turnover ratio analysis can help predict when the AR will be received.
Unveiling the Essence of Accounts Receivable (AR)
Accounts receivable refer to the outstanding invoices that a company holds or the money owed by clients. This term includes any accounts that a business has the right to receive because it has provided a product or service.
Receivables often have terms for payment due within a relatively short period, ranging typically from a few days to a fiscal or calendar year. Given that there is a legal obligation for the customer to pay, companies record accounts receivable as assets. Considered liquid assets, they can be utilized as collateral to secure short-term loans and are integral to a company’s working capital.
As current assets, accounts receivable indicate amounts that are due from debtors within a year or less. Essentially, it signifies that a sale on credit has been made, but the payment hasn’t yet been collected—akin to a short-term IOU from the client.
Accounts Receivable vs. Accounts Payable
When debts are owed to suppliers or other parties, these are known as accounts payable. Accounts payable are the opposite of accounts receivable. For example:
- Company A cleans Company B’s carpets and sends a bill for the services.
- Company B owes money, recording the invoice in its accounts payable ledger.
- Company A, waiting to receive payment, records the bill as accounts receivable.
Revealing Insights Through Accounts Receivable
Accounts receivable provide crucial insights into a business’s financial health. As a current asset, AR measures a company’s liquidity—or its ability to cover short-term obligations without additional cash flow inputs.
Fundamental analysts evaluate accounts receivable using turnover, referred to as the accounts receivable turnover ratio, which gauges how many times a company has collected its AR balance in an accounting period. Another critical measure is days sales outstanding (DSO), which calculates the average number of days taken to collect payment after a sale.
Energizing Examples of Accounts Receivable
An illustrative example is an electric company that bills customers post-electricity usage. It records unpaid invoices as accounts receivable while awaiting payments.
Most businesses offer part of their sales on credit, sometimes to repeat or special clients who receive periodic invoices, streamlining payment without frequent transactions. Other companies offer post-service payment as a standard policy.
Practical Insights into Receivables
A receivable is created any time money is owed to a firm for services rendered or products provided but yet unpaid. These can arise from in-store credit sales, subscriptions, or installment payments due post-product or service delivery.
Unearthing AR on Balance Sheets
Accounts receivable are found on a company’s balance sheet and are recognized as assets due to funds owed to the enterprise. Investors must analyze these entries to verify sound financial practices.
Handling Unpaid Accounts Receivable
If it becomes evident that a customer won’t pay the owed AR, it must be written off as a bad debt expense or a one-time financial charge. Alternatively, this outstanding debt might be sold to a third party, referred to as AR factoring.
Distinguishing AR from Accounts Payable
While accounts receivable represent funds owed to a company (booked as assets), accounts payable refer to funds the company owes to others, like supplier payments, and are considered liabilities.
Emphasizing the Significance:
Accounts receivable stand as a vital component on a company’s balance sheet. Quick AR turnover is favorable, representing a company’s efficiency in getting paid and subsequently reinvesting the funds into the business.
Related Terms: Accounts Payable, Liquid Assets, Working Capital, Bad Debt Expense.
