How to Calculate the Accounts Receivable Balance
Determine your accounts receivable balance. Gain clarity on outstanding revenue to assess your business's financial health.
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, reflecting outstanding invoices. AR is a current asset, typically collected within one year. Its proper management is important for a company’s liquidity and overall financial health.
Understanding Accounts Receivable
Accounts receivable arises when a business extends credit, allowing customers to receive products or services immediately with a promise to pay later. The primary document initiating an accounts receivable entry is the invoice. An invoice is a formal request for payment that details the transaction, including the customer’s name, sale date, description of goods or services, total amount due, and payment terms.
Payment terms specify when the invoice amount is due. Common terms include “Net 30” (payment within 30 days from invoice date) or “Net 60” (60-day payment period). These terms determine the credit period extended to the customer and when the receivable becomes past due. Businesses track outstanding invoices to monitor who owes them money and for how long, which helps ensure timely collection efforts.
Calculating the Accounts Receivable Balance
Calculating the gross accounts receivable balance involves summing all outstanding invoices owed by customers as of a specific date. This initial sum represents the total amount customers are legally obligated to pay for goods or services already received on credit.
Businesses must then consider that not all outstanding invoices may be fully collected. This introduces the concept of the “Allowance for Doubtful Accounts,” which is an estimated amount of accounts receivable that may never be collected. This allowance is a contra-asset account, meaning it reduces the total accounts receivable to reflect a more realistic collectible amount.
Estimating this allowance is commonly done using methods such as the percentage of sales method or the aging of receivables method. The percentage of sales method involves applying a historical percentage of credit sales that typically become uncollectible. The aging of receivables method categorizes outstanding invoices by their age (e.g., 0-30 days, 31-60 days, 61-90 days, over 90 days) and applies higher uncollectible percentages to older invoices.
Once the Allowance for Doubtful Accounts is estimated, it is subtracted from the gross accounts receivable to arrive at the net realizable value of accounts receivable. This net figure represents the amount of cash a company genuinely expects to collect from its outstanding customer balances. Reporting accounts receivable at its net realizable value on the balance sheet ensures that assets are not overstated, aligning with accounting principles that prioritize a conservative and accurate financial representation.
Key Accounts Receivable Metrics
Several key metrics provide insights into a company’s accounts receivable performance. Two important metrics are the Accounts Receivable Turnover Ratio and Days Sales Outstanding (DSO). These calculations help assess how efficiently a business manages its credit and collects payments.
The Accounts Receivable Turnover Ratio measures how efficiently a company collects its credit sales. It indicates the number of times a company collects its average accounts receivable over a specific period. The formula for this ratio is Net Credit Sales divided by Average Accounts Receivable.
Net credit sales are total credit sales minus any sales returns or allowances. Average accounts receivable is found by adding the beginning and ending accounts receivable balances for the period and dividing by two. A higher turnover ratio indicates effective collection practices and quicker conversion of receivables into cash.
Days Sales Outstanding (DSO) measures the average number of days it takes for a company to collect its accounts receivable. The formula for DSO is (Accounts Receivable / Net Credit Sales) multiplied by the Number of Days in the Period. A lower DSO suggests that a company is collecting its receivables more quickly, which can improve cash flow and liquidity. Conversely, a consistently high DSO might signal issues with collection processes or customer payment delays.