Accounts receivable is the money owed to a business for the sale of goods or services already delivered. Businesses often extend this type of short-term credit to customers by creating an invoice or bill to be paid at a later date. Accounts receivable is considered an asset and is listed as such on a business’s balance sheet.
To understand how accounts receivable works for your business, you’ll need to learn what this important financial component is, how to record it, why it’s important for business analysis, and how it differs from accounts payable.
Definition and Examples of Accounts Receivable
Accounts receivable is the balance owed by customers to a business for goods and services that the latter has sold or provided on credit. In other words, any money that a business has a right to collect as payment is listed as accounts receivable.
Entering accounts receivable is normal practice for a business any time services are rendered and before an invoice is created and delivered to the customer.
- Alternate name: Unpaid invoice, balance due
- Acronym: AR
For example, say a plumber is called to repair a busted pipe at a client’s house. Once the plumber completes the job, they give the invoice of $538 to the customer for the completed job. That customer’s bill of $538 will be recorded by the plumber as accounts receivable while they wait for the customer to pay the invoice.
How To Record Accounts Receivable
Accounts receivable are recorded in a business’s general ledger and reported as part of the current assets listed on its balance sheet since these receivables are expected to be paid and converted into cash within a year. So if your photography business invoices a client for $250 for a photo shoot, $250 would be debited from the accounts receivable and credited to sales on the general ledger. The accounts receivable balance would show up under current assets on the company balance sheet. Once the payment is received by the customer, the business can then record the payment.
Accounts Receivable for Business Analysis
The accounts receivable turnover ratio shows the rate at which accounts receivable is collected on an annual basis and is calculated using this formula:
Net annual credit sales ÷ average accounts receivable
The calculation for average accounts receivable itself is:
(Beginning accounts receivable + ending accounts receivable ÷ 2)
Because it highlights your company’s liquidity, the accounts receivable turnover can be a great tool for financial analysis that can help you gauge your company’s financial health. It can also reveal your business’s ability to maintain consistent cash flow without the need to convert larger assets into cash.
Investors and lenders often review a company’s accounts receivable ratio to determine how likely it is that customers will pay their balances. It’s important to note that your business can have a high number of sales but not enough cash flow because of uncollected receivables. Uncollected accounts receivable can hurt your business by reducing your liquidity and limiting your company’s prospects.
Accounts Receivable vs. Accounts Payable
Accounts receivable and accounts payable are essentially on opposite sides of the balance sheet. While accounts receivable is money owed to your company (and considered an asset), accounts payable is money your company is obligated to pay (and considered a liability).
For example, it’s standard practice for a physician who has conducted a client exam to send an invoice to the client’s medical insurance company. That physician may also invoice the customer for any remaining balance the insurance did not cover. The physician’s office would then record both balances owed in its accounts receivable until it receives payment. From their end, the insurance company responsible for a portion of the client’s payment will document the balance it owes to the physician as accounts payable.
Accounts Receivable Time Frame
Consider how long your business will extend credit to a customer. Typically, accounts receivables are due in 30 to 60 days and are considered overdue past 90. The timing can depend on your industry.
Generally, collecting a balance too quickly can put undue stress on clients with good standing. However, waiting too long to collect can cause you to lose the opportunity for payment. Selecting the ideal times to allow delayed payment will help you keep a good balance between being flexible and ensuring prompt payment.
- Accounts receivable are balances due to a business for services or goods delivered to a customer.
- On a business’s balance sheet, accounts receivables are considered current assets.
- The accounts receivable turnover ratio is calculated by dividing net annual credit sales by average accounts receivable.
- Typically, accounts receivable are due in 30 to 60 days and considered well overdue past 90, but time frames can vary based on industry.