Accounts Receivable (AR) represents the credit sales of a business, which have not yet been collected from its customers. Companies allow their clients to pay for goods and services over a reasonable extended period of time, provided that the terms have been agreed upon. For certain transactions, a customer may receive a small discount for paying the amount due to the company early.
What Is Accounts Receivable (AR)?
Accounts receivable (AR) is an accounting term for money owed to a business for goods or services that it has delivered but not been paid for yet. Accounts receivable is listed on the company’s balance sheet as a current asset.
Understanding Accounts Receivable (AR)
Accounts receivable represents money that a business is owed by its clients, often in the form of unpaid invoices. “Receivable” refers to fact that the business has earned the money because it has delivered a product or service but is, at that point in time, still waiting to receive the client’s payment.
Accounts receivable, or receivables, can be considered a line of credit extended by a company and normally have terms that require payments be made within a certain period of time. If effect, the company has accepted an IOU from the client. Depending on the agreement between company and client, the payment might be due in anywhere from a few days to 30 days, 60 days, 90 days, or, in some cases, up to a year. At some point along the way, interest on the debt might also begin to accrue.
Companies record accounts receivable as assets on their balance sheets because the customer has a legal obligation to pay the debt and the company has a reasonable expectation of collecting it. They are considered liquid assets because they can be used as collateral to secure a loan to help the company meet its short-term obligations. Receivables are part of a company’s working capital.
Why do Companies have Accounts Receivable?
Some businesses allow selling on credit to make the payment process easier. Take, for example, a phone provider. The provider may find it hard to collect payment perpetually every time someone makes a call. Instead, it will bill periodically at the end of the month for the total amount of service used by the customer. Until the monthly invoice has been paid, the amount will be recorded in accounts receivable.
Allowing purchases on credit also encourages more sales. Customers are more likely to buy items if they can pay for them at a later date.
For someone working in FP&A, equity research, or investment banking, it’s important to understand the cash conversion cycle – the amount of time it takes a company to convert its inventory into sales and then cash – as it provides important information on the company’s cash flow.
Risks of Outstanding Accounts Receivable Balances
- Uncollected debt – High A/R that goes uncollected for a long time is written off as bad debt. This situation occurs when customers who purchase on credit go bankrupt or otherwise do not pay the invoice.
- Cash flow deficiencies – A business needs cash flow for its operations. Selling on credit may boost revenue and income, but it offers no actual cash inflow. In the short term, it is acceptable, but in the long term, it can cause the company to run short on cash and have to take on other liabilities to fund operations.
Accounts Receivable vs. Accounts Payable
When a company owes debts to its suppliers or other parties, those are accounts payable. Accounts payable are the opposite of accounts receivable. To illustrate, Company A cleans Company B’s carpets and sends a bill for the services.
Company B now owes Company A money, so it lists the invoice in its accounts payable column. While Company A waits to receive the money, it records the amount in its accounts receivable column.
FAQs
When Does a Debt Become a Receivable?
A receivable is created any time money is owed to a business for services rendered or products provided that have not yet been paid for. For example, when a business buys office supplies, and doesn’t pay in advance or on delivery, the money it owes becomes a receivable until it’s been received by the seller.
How Are Accounts Receivable Different From Accounts Payable?
Accounts receivable represent funds owed to a company and are booked as an asset. Accounts payable, on the other hand, represent funds that a company owes to others and are booked as liabilities.