How to Calculate and Analyze Accounts Receivable

Accounts receivable (AR) represents money owed to a business by its customers for goods or services delivered on credit. This financial asset appears on a company’s balance sheet, signifying future cash inflows. Understanding AR is important because it directly impacts a company’s liquidity and financial health. Businesses rely on these payments to manage daily operations, invest in growth, and maintain cash flow.

Identifying Components of Accounts Receivable

Calculating accounts receivable begins with meticulous record-keeping of credit sales transactions. Each time a business sells goods or provides services on credit, a sales invoice is generated. This invoice details the amount owed, items purchased, and payment terms.

Credit terms, such as “Net 30” or “2/10 Net 30,” specify when payment is due and any discounts for early payment. “Net 30” indicates the full amount is due within 30 days from the invoice date. “2/10 Net 30” allows a 2% discount if paid within 10 days, otherwise the full amount is due in 30 days. Individual customer accounts track all transactions, including invoices, payments received, and adjustments. These records are maintained within a sales ledger, also known as an accounts receivable ledger. The sales ledger provides a comprehensive history for each customer.

Calculating Total Accounts Receivable

Determining total outstanding accounts receivable involves summing all unpaid customer invoices as of a specific date. Businesses use an accounts receivable subsidiary ledger, which tracks individual customer accounts and their balances. This ledger provides a breakdown of amounts owed by each customer.

To arrive at the total accounts receivable, balances from all individual customer accounts within the subsidiary ledger are added together. This summation provides a comprehensive figure representing the total money owed to the business from its credit sales. An accounts receivable aging schedule can also aid this summation process. While primarily used for analysis, an aging schedule lists all outstanding invoices, categorized by how long they have been due. By compiling all current and past-due invoices from this schedule, the total accounts receivable balance can be accurately calculated.

Analyzing Accounts Receivable Performance

Analyzing accounts receivable performance involves calculating financial ratios that provide insight into a company’s collection efficiency. Days Sales Outstanding (DSO) measures the average number of days it takes for a business to collect its credit sales. The formula for DSO is (Accounts Receivable / Total Credit Sales) Number of Days in Period. A lower DSO indicates quicker payment collection, suggesting efficient credit policies and collection efforts.

The Accounts Receivable Turnover Ratio assesses how efficiently a company converts its accounts receivable into cash over a period. This ratio is calculated by dividing Net Credit Sales by Average Accounts Receivable. A higher accounts receivable turnover ratio signifies effective credit management and prompt collection of payments from customers. Conversely, a lower ratio might indicate issues such as overly lenient credit terms, customer payment delays, or less effective collection procedures.

Reconciling Accounts Receivable

Reconciling accounts receivable ensures the accuracy of the recorded AR balance. This process verifies that the total balance in the accounts receivable subsidiary ledger matches the Accounts Receivable control account in the general ledger. The reconciliation process begins by summing individual customer balances from the accounts receivable subsidiary ledger. This sum represents the total amount owed by all customers at a specific point in time.

This total from the subsidiary ledger is then compared to the balance reported in the Accounts Receivable control account within the company’s general ledger. Any differences between these two figures require investigation to identify the cause of the discrepancy. Common reasons for variances include unrecorded payments, incorrect postings, or errors in data entry. Once discrepancies are identified, adjustments are made to correct the balances, ensuring both ledgers accurately reflect the outstanding accounts receivable.