How to Calculate Average Accounts Receivable

Accounts receivable represents money owed to a company for goods or services provided on credit. Managing these outstanding balances effectively is important for maintaining healthy cash flow and operational stability. Understanding how to calculate the average amount of these receivables provides valuable insight into a company’s financial practices.

What Average Accounts Receivable Measures

Accounts receivable (AR) refers to money customers owe a business for products or services received but not yet paid for. Typically, businesses extend credit to customers, allowing them to pay at a later date, often within a specified period like 30 or 60 days. This practice creates accounts receivable, which are recorded as a current asset on the company’s balance sheet, reflecting expected future cash inflows.

Calculating the average accounts receivable provides a smoothed view of outstanding balances over a specific period, such as a month, quarter, or year. This average helps normalize fluctuations from seasonal sales or uneven billing cycles. It is a key indicator of how efficiently a company manages its credit policies and collection efforts, impacting overall liquidity and financial stability.

Preparing for the Calculation

To calculate the average accounts receivable, you need two primary data points: the accounts receivable balance at the beginning and end of the chosen period. These figures are available within a company’s financial records.

Specifically, the accounts receivable balance can be found under the “current assets” section of a company’s balance sheet. Alternatively, a business’s general ledger or accounting software provides detailed accounts of all financial transactions. For a more comprehensive view of individual customer obligations, the accounts receivable subsidiary ledger offers granular detail.

Steps to Calculate Average Accounts Receivable

Calculating average accounts receivable is a straightforward process, providing a representative figure for outstanding customer balances. The most common method involves summing the beginning and ending accounts receivable balances for a period and then dividing that total by two. This approach is widely used for short-term financial analysis.

The formula is: Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2. For instance, if a company’s accounts receivable balance was $50,000 at the start of a year and $70,000 at the end, the calculation would be ($50,000 + $70,000) / 2. This results in $120,000 / 2, yielding an average accounts receivable of $60,000 for the year. This average represents the typical amount of money owed to the business by its customers over that period.

What the Average Accounts Receivable Indicates

The average accounts receivable figure offers valuable insights into a company’s operational efficiency and financial health. A lower average accounts receivable suggests a business is efficient in collecting payments from customers and has robust credit policies. This efficiency translates to better cash flow, as money owed is converted into usable funds more quickly, improving the company’s ability to meet short-term obligations and invest in growth.

Conversely, a consistently higher average accounts receivable may suggest factors like lenient credit policies, increased credit sales volume, or collection challenges. While increased sales can naturally elevate this average, a high figure could also signal potential cash flow shortages or an increased risk of uncollectible debts. Businesses often compare their average accounts receivable to industry benchmarks or historical data to assess performance and identify areas for improvement.