What Is Accounts Receivable?
AR/accounts receivable is any money owed by customers to a company. In other words, it’s money that a company has a right to receive because it has provided a product or service. However, the company has not received the money yet.
A customer often receives some sort of product or service but has an amount of time, or a term, to pay the amount owed. The term, which is often 30, 60, or 90 days, provides some flexibility to the client, customer, or other company to pay it off.
Accounts Receivable Terms and Definitions
You could define accounts receivable simply by saying it’s the balance due for goods and services that have been delivered but not paid for yet. Here are a few related accounts receivable terms that may be useful:
- Accounts Receivable Turnover Ratio: A measurement that shows how efficiently a company can collect receivables from customers
- Average Collection Period: The amount of time it takes for a business to receive payment from customers and clients
- Current Liabilities: A business’s obligations and debts that are owed to creditors
What Are Some Accounts Receivable Examples?
Let’s say that Sue wants to buy a $3,000 gazebo but doesn’t have that amount at the time of the sale. The gazebo-sellers would allow her 30 days to pay off her debt. During that time, the sellers would have $3,000 listed in their accounts receivable. When she pays it off, that amount would go back to the sales amounts or cash flow.
That’s an example of how things work in an ideal situation. But what if Sue doesn’t pay off the gazebo within 30 days? In that case, the money would still be owed, and the company would be out the money. That’s why accountants define accounts receivable differently than sales. The next step in this situation is to contact the customer or to move on with contacting a collections agency. It’s important to note that companies that sell on credit may not have an actual lien on the property. This means that the full amount owed on the property may not be collected.
What Is the Difference Between Accounts Receivable and Accounts Payable (AP vs. AR)?
In accounting, accounts payable (AP) and accounts receivable (AR) are opposites. When Company A buys services from Company B, Company B will send them a bill. Company A owes money, so they will record this debt in their accounts payable column. While Company B waits to receive the money, they will record the bill in their accounts receivable records.
How Does Accounts Receivable Work?
If your business invoices customers who will pay over time, then your business has accounts receivable. Here’s a quick guide to how to do accounts receivable accounting.
- Create an invoice for services performed. Ensure that your invoice has the following information:
- 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
- Debit and credit the proper accounts within your accounts receivable accounting systems.
- Debit accounts receivable for the amount due from your customer.
- Credit sales for the same amount.
- Collect payment from your customer.
- Debit and credit the proper accounts to show payment.
- Debit cash to show an increase due to the payment.
- Credit accounts receivable to reduce the amount owed by your customer.
Tips for Collecting on Accounts Receivable
Companies can employ a variety of tactics:
- Charge a late fee for outstanding payments or otherwise penalize customers in some way
- Reward good behavior by offering a discount to those who pay quickly
- Have an efficient follow-up process for these accounts
- Use a reliable collections agency
- Keep better track of these accounts with an in-house or outsourced accounting firm
Risks and Benefits of Accounts Receivable
There is a potential risk with having a large amount of AR/accounts receivable. By definition, the success of the concept depends entirely on the reliability of the debtors. It’s also an important responsibility of the company to follow up with outstanding invoices or payments. An “aging” account receivable is dangerous, as it is unlikely to be paid back in full.
Why would anyone award a customer credit like this, since it is potentially so problematic? In terms of bookkeeping, it can have a positive effect. AR is considered to be a part of working capital and is considered an asset on balance sheets. It also provides a trusted group of customers with enough flexibility to pay large sums. Certain industries do very well with having working, regulated accounts receivable.
Is Accounts Receivable an Asset or Liability?
Accounts receivable may be money owed by the customer or client, but because this is convertible to cash in the future, accounts receivable is considered an asset. A balance sheet lists accounts receivable among current assets. If the business has to wait more than one year to convert AR to cash, it’s considered a long-term asset.
Need help managing your accounts receivable? Ignite Spot offers expert outsourced accounting services that can help a small business stay on top of its accounts receivable and many other common bookkeeping issues. To learn more about what is accounts receivable and how management of these accounts can help your company, download our free audiobook about financial success, then contact us at Ignite Spot today to get started boosting your profitability.
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Written by Eddy Hood