Understanding Accounts Receivable (AR)
Accounts receivable (AR) refers to the balance of money due to a company for goods or services provided, but not yet paid for by customers. On the balance sheet, AR is listed as a current asset because it usually represents an amount of payment expected in the near term. Accounts receivable form part of a company’s working capital and are much like an IOU from customers. As such, they are considered liquid assets capable of being used to improve immediate financial flexibility. When companies extend credit for purchases, they create AR entries to denote this expected revenue.
Key Takeaways
- Accounts receivable is a crucial current asset reflecting the revenue expected from customers.
- ARs emerge when a company extends credit to a buyer for goods or services.
- Accounts payable is the counterpart to AR, representing money a company owes to suppliers.
- Tools like accounts receivable turnover ratio and days sales outstanding (DSO) are often used to analyze AR.
- Efficient management of AR helps ensure businesses receive payment promptly, optimizing cash flow.
Accounts Receivable vs. Accounts Payable
When a business owes money to suppliers or similar parties, it records this as accounts payable. AR is the flip side—tracking money owed to the business by customers. Here’s an example: if Company A services Company B’s equipment on credit, Company B logs this debt as accounts payable, while Company A records it as accounts receivable waiting to be settled.
What AR Tells You About a Business
Accounts receivable provides insight into a company’s liquidity. Analysts examine AR turnover ratios—how often the AR balance is collected over a period—to gauge efficient collection practices. Days sales outstanding (DSO) is another metric helping businesses monitor how swiftly they transform sales into cash.
Illustrative Example of AR
A utility company typically bills customers after services, creating AR once the invoice is sent. This is a standard practice allowing businesses to manage customer payments without immediate cash exchange, assuring continuous service delivery while waiting for payment.
Examples of Receivables
Receivables account not only includes sales on credit but also subscription dues or installment payments pending after service or product delivery. Anytime a payment is expected but not yet received, it is marked as AR.
Locating a Company’s AR on the Balance Sheet
On the balance sheet, AR is shown under current assets. For investors, analyzing these figures can be an insightful way to determine if a business is managing its payment collections effectively.
Handling Unpaid AR
When AR fails to be collected, businesses may write off these amounts as bad debt expenses or sell these debts through AR factoring, effectively transferring the risk while regaining part of the expected revenue.
Distinction from Accounts Payable
While AR denotes money to be collected, accounts payable signifies sums a business owes, thus presented as liabilities on the balance sheet. Understanding both is crucial for comprehensive financial health analysis.
The Bottom Line
Keeping AR as short-term as possible helps maintain robust cash flow. Timely collection enhances financial agility, allowing companies to reinvest promptly into other critical business functions.
Related Terms: Liquid Assets, Working Capital, Accounts Payable, Accounts Receivable Turnover Ratio, Days Sales Outstanding.
