Accounts receivable is the money that a customer owes to a business for goods or services that have been delivered but not yet paid for. It is an essential component of a company's financial health and can affect the company's cash flow. In this article, we will explore what accounts receivable is and how it works, its components, management, evaluation, and differences between accounts receivable and accounts payable.

What is Accounts Receivable and How Does it Work?

Definition of Accounts Receivable

Accounts receivable, also known as AR, is a current asset account that records an account receivable when a customer purchases a good or service but has not yet paid for it.

How Does Accounts Receivable Work?

When a customer purchases goods or services from a business, an invoice or bill is created, specifying the amount owed and the payment terms. Payment terms can vary, but they are usually within 30, 60, or 90 days.

Once the customer receives the invoice, they have a certain amount of time to pay the amount owed. The customer is considered to owe the business money until the bill is paid, and the amount owed is listed as accounts receivable.

Benefits of Accounts Receivable

Accounts receivable is an important aspect of a business's financial operations, as it allows a company to track the money owed to them by their customers. With accounts receivable, businesses can monitor their cash flow, identify late payments, and ensure timely payments by their customers. Managing accounts receivable efficiently is crucial for a healthy business and customer satisfaction.

What are the Components of Accounts Receivables?

Invoice or Bill

An invoice or bill is a document specifying the amount owed for goods or services delivered by the business to its customers. It outlines the details of the transaction, including the payment terms.

Payment Terms

The payment terms are specified in the invoice and relate to the period in which a customer must pay the invoice. Payment terms can range from 30 to 90 days, and businesses must make sure they are adhered to strictly, to maintain good customer relationships and cash flow.

Accounts Receivable Aging Schedule

The accounts receivable aging schedule is a report that lists the outstanding balances of all customer accounts and categorizes them by the length of time since the invoice became due. This report is essential in determining which customers owe money and which ones are overdue for payment.

How to Manage AR Efficiently?

Cash Flow

Managing cash flow is critical for businesses to operate smoothly and efficiently. One way to ensure this is to have an efficient accounts receivable collection process that is consistent and timely. This process involves sending invoices promptly, following up with customers for late payments, and implementing a payment plan for overdue accounts.

Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio measures how many times accounts receivable are collected within a given period. A high ratio indicates that a company is collecting its accounts receivable quickly, while a low ratio suggests the opposite and is an indication of potential cash flow problems.

Bad Debt

Bad debt refers to unpaid accounts receivable, which cannot be collected. It can negatively impact a company's cash flow and should be minimized as much as possible. Businesses can use credit checks and contracts to avoid bad debt and consider hiring professional debt collectors to help recover bad debt.

How to Evaluate Accounts Receivable?

Current Asset

Accounts receivable is listed as a current asset in the balance sheet, indicating that it is expected to be converted into cash within a year. Companies should evaluate their accounts receivable regularly to determine whether they have enough cash for short-term obligations, such as inventory, payroll, and rent payments.

Balance Sheet

The balance sheet provides a snapshot of a company's financial position, listing its assets, liabilities, and equity. Businesses can examine the accounts receivable balance in the balance sheet to determine how much money they are owed and how much they need to collect to maintain healthy cash flow.

Liquidity

Liquidity refers to a company's ability to meet its short-term obligations, such as paying bills and debts. Evaluating accounts receivable is crucial to assessing a company's liquidity, as it provides insight into the money due but not yet paid.

What are the Differences Between Accounts Receivable and Accounts Payable?

Definition of Account Payable

Accounts payable refers to the money that a company owes to its suppliers for goods and services that have been delivered but not yet paid for.

Differences Between Accounts Receivable and Accounts Payable

The main difference between accounts receivable and accounts payable is that accounts receivable are the money owed to a company, while accounts payable are the money that a company owes to its suppliers. Accounts payable are listed as a current liability in the balance sheet since the company needs to pay its debts within a year, while accounts receivable are listed as a current asset since the company expects to collect the money within a year.

Overall, accounts receivable are a critical part of a company's financial operations, and managing it efficiently is essential for maintaining a healthy business. Businesses can use accounting software such as QuickBooks, Xero, Shopify, or Wave to manage their accounts receivable and ensure timely payments by their customers.