How to Figure Out Your Accounts Receivable

Accounts receivable (AR) represents money owed to a business for goods or services that have been delivered or provided on credit. It is a current asset on the balance sheet, reflecting sales that have been made but not yet collected in cash. This amount helps understand a company’s immediate financial health and its ability to generate cash. Recognizing revenue when goods or services are delivered, even if payment is not immediate, impacts a business’s reported earnings and overall financial position.

Calculating Gross Accounts Receivable

The initial step in understanding accounts receivable involves identifying and summing the total amount customers owe before any adjustments. Accounts receivable primarily originate from credit sales where a business extends terms allowing customers to pay at a later date, typically within 30 to 90 days. Each time a product is sold or a service is rendered on credit, an invoice is issued, creating a record of the amount due.

Businesses track these amounts through various means, ranging from simple spreadsheets for small operations to integrated accounting software for larger entities. A small business might maintain a manual ledger or a spreadsheet, listing each outstanding invoice by customer, invoice number, amount, and due date. For instance, if a landscaping company completes a project and issues a $1,500 invoice due in 30 days, that $1,500 contributes to its gross accounts receivable.

Larger businesses use accounting software, such as QuickBooks or SAP, which include accounts receivable modules. These systems automatically record credit sales, generate invoices, and track payments received, providing a real-time summary of outstanding balances. Accurate sales records and timely invoice issuance are important for calculating this gross amount.

Adjusting for Uncollectible Accounts

After calculating gross accounts receivable, businesses must refine this figure to reflect the amount they realistically expect to collect. This refinement accounts for uncollectible accounts, also known as bad debts, which are invoices that customers are unlikely to pay. The generally accepted accounting principles (GAAP) require businesses to estimate and recognize these potential losses to ensure financial statements accurately portray the net realizable value of accounts receivable. This adjustment is recorded through an “Allowance for Doubtful Accounts,” a contra-asset account that reduces the gross accounts receivable to its estimated collectible amount.

Two common methods are employed to estimate uncollectible accounts. The first is the Percentage of Sales Method, which estimates bad debts as a percentage of total credit sales for a period. For example, if historical data indicates 2% of credit sales become uncollectible, and a business had $100,000 in credit sales, it would estimate $2,000 as uncollectible. This method focuses on the income statement impact by matching bad debt expense with the sales it helped generate.

The second approach is the Aging of Accounts Receivable Method, which provides a more detailed estimate by categorizing outstanding invoices based on how long they have been overdue. Older invoices are assigned a higher probability of becoming uncollectible. For instance, invoices 1-30 days overdue might be estimated as 2% uncollectible, while those 91-120 days overdue might be estimated as 20% uncollectible. A business sums the estimated uncollectible amount for each age bracket to arrive at the total allowance needed. This method focuses on the balance sheet, aiming to state accounts receivable at its net realizable value.

Managing and Monitoring Accounts Receivable

Effective management of accounts receivable involves ongoing processes and the use of specific tools to maintain accuracy and track outstanding balances after initial calculation and adjustment. Regular reconciliation of accounts receivable records with bank statements and customer payment remittances is a practice. This ensures that all payments received are accurately applied to customer accounts and that the reported outstanding balances are correct. Discrepancies found during reconciliation are investigated and corrected promptly, preventing misstatements of the receivable balance.

Accounting software, such as QuickBooks, Xero, or Sage, automates many aspects of accounts receivable management. These systems streamline the creation and delivery of invoices, automatically track payment due dates, and record incoming payments. These platforms also offer features like automated payment reminders and electronic invoicing, which can improve collection efficiency.

Businesses use several accounts receivable reports to monitor their status. The accounts receivable aging report categorizes outstanding invoices by their due dates, highlighting overdue amounts and their age. This report helps identify customers with past-due balances and prioritize collection efforts. Customer statements, which summarize all invoices, payments, and credits for a specific customer, are also regularly generated and sent to provide clarity and encourage timely payments. Internal processes for managing accounts receivable include establishing clear credit terms with customers, such as “Net 30” (payment due in 30 days), and consistently following up on overdue invoices through phone calls or collection letters.