Accounts Receivable

Accounts receivable (A/R) represents the money owed to a business by its customers for goods or services delivered but not yet paid for. It is recorded on the balance sheet as an asset and indicates the company's right to collect payment in the near future. Its counterpart is accounts payable (A/P).

A/R is a vital aspect of a business's finances, representing the money customers owe for goods and services provided on credit. Efficient A/R management ensures companies can ensure timely fund collection and improve their liquidity, reduce the risk of bad debts (debt unable to be collected), and ensure accurate financial reporting and company health. While it is important for all organizations, effective accounts receivable management is particularly crucial for small businesses, where cash flow is often tight.

• High Impact on Cash Flow: Effectively managing accounts receivable is important for maintaining healthy cash flow and shows as a short-term asset.
• Part of Working Capital: Like accounts payable, A/R is a key component of a company's working capital management, which calculates its current assets minus current liabilities.
• Process: Involves issuing invoices to customers, tracking payments using various methods, and managing collections when invoices become overdue. It is the flip side of A/P.
• Financial Stability: High accounts receivable can indicate strong sales but may also suggest issues with collection efficiency if large sums sit uncollected for periods of time. Generally, a business wants a high accounts receivable figure that fluctuates consistently as invoices are collected.
• Customer Relationships: Effective A/R management can strengthen customer relationships and improve cash flow predictability, which is essential for any business but more important to some.

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Accounts Receivable Process

Accounts receivable is a component of a company's financial operations, reflecting its ability to extend credit to its customers. This process includes:

1. Issuing Invoices: When the company sells goods or provides services on credit, it issues an invoice to the customer detailing the amount owed and the payment terms.
2. Tracking Payments: Likely with the help of software, the company monitors the status of any outstanding invoices, tracking which ones have been paid and which are still pending.
3. Managing Collections: If invoices remain unpaid past their due date, the company may need to follow up with customers to collect the owed amounts. The last resort for customers who are entirely unwilling or unable to make a payment is to send the invoice to a collection agency, who will charge the business a fee for any invoice amount they can collect from the customer.

Common Payment Terms

• Due on Receipt: The payment is due immediately. These terms are more common in the accounts receivable process than in the accounts payable process. A typical example would be if a customer visited a website and paid immediately upon checking out, before receiving any goods or services. Think Amazon or any other online purchase.
• Net 30: The invoice is due 30 days from the invoice date.
• Net 60: The invoice is due 60 days from the invoice date.
• Net 90: The invoice is due 90 days from the invoice date.
• 3/10 Net 30: The invoice is due 30 days from the invoice date, but the customer will receive a discount of 3% if the invoice is paid within the first ten days of issuance. Terms like this are much more common in business-to-business transactions and accounts payable.

Accounts Receivable Best Practices

• Clear Payment Terms: Establishing and communicating clear payment terms helps set customer expectations.
• Timely Invoicing: Sending invoices promptly after delivering goods or services ensures quicker payment.
• Regular Follow-Ups: Regularly following up on overdue invoices can help accelerate collections.
• Offering Discounts: Providing early payment discounts can incentivize customers to pay sooner.
• Using Technology: Implementing A/R software can automate invoicing, reminders, and tracking, reducing manual errors and increasing efficiency. QuickBooks, NetSuite, and Bill.com are good examples.

Importance in Financial Statements

Accounts receivable appear on the balance sheet under current assets, reflecting the money expected to be received within the next fiscal year. It is a crucial indicator of a company's liquidity and short-term financial health. A/R can also be analyzed through the cash flow statement in the operating activities, showing the actual cash inflows related to assets.

Impact on Cash Flow

Accounts receivable significantly impact cash flow. While sales increase accounts receivable and potentially boost revenue figures, the actual cash is only realized once the invoices are paid. Effective A/R management ensures the company has enough cash currently to meet its obligations and invest in growth opportunities.

Financial Ratios Involving Accounts Receivable

Accounts Receivable Turnover Ratio: Measures how efficiently a business collects its receivables. A higher ratio indicates good efficiency, while a lower ratio indicates a slower collection of money. Formula calculated as:

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(Net Credit Sales) / (Average Accounts Receivable)


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Days Sales Outstanding (DSO): Indicates the average number of days it takes to collect payment after the sale is made. As opposed to the accounts receivable turnover ratio, a low DSO number is good because it means a business is not waiting very long before being paid; a high DSO number means credit is being extended and the business is waiting longer to receive cash payments. Formula calculated as:

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(Accounts Receivable) / (Net Credit Sales/365 Days)


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While there are general interpretations of the ranges of these formulas, different industries will vary significantly.

Critical Considerations of A/R

• Credit Policies: Establishing strong credit policies helps mitigate the risk of non-payment.
• Customer Creditworthiness: Assessing customers' creditworthiness before extending credit can reduce the likelihood of bad debts.
• Regular Monitoring: Continuously monitoring the accounts receivable aging report helps identify overdue accounts and take necessary actions.