Is Accounts Receivable a Source or Use of Cash?

Businesses sell goods or services, sometimes for immediate cash, other times on credit, creating accounts receivable. This money owed can cause confusion regarding its impact on cash flow. Understanding whether accounts receivable acts as a source or use of cash is crucial for assessing a business’s financial health and liquidity.

What Are Accounts Receivable?

Accounts receivable represents money customers owe a business for goods or services. It arises from credit sales. This is recorded as a current asset on a company’s balance sheet, expected to be received within a relatively short period, typically one year.

For example, when a service provider completes a project for a client and issues an invoice with 30-day payment terms, the amount due becomes an accounts receivable. Accounts receivable is considered an asset because it represents a future economic benefit that will be converted into cash.

Understanding Sources and Uses of Cash

Businesses engage in activities that either increase or decrease their cash balances. A “source of cash” brings money into the company. Examples include collecting money from customers for sales, receiving loan proceeds, or issuing new equity shares.

Conversely, a “use of cash” expends money. This can involve paying for operational expenses like salaries or rent, purchasing new equipment, or repaying debt. These concepts are essential for interpreting a company’s cash flow statement.

How Accounts Receivable Impacts Cash Flow

An increase in accounts receivable is considered a use of cash. This occurs because a sale is made and revenue recognized, but cash not yet collected. For instance, if a company sells $10,000 worth of goods on credit, its accounts receivable increases by $10,000, tying up $10,000 in cash.

Conversely, a decrease in accounts receivable represents a source of cash. When customers pay their outstanding invoices, the accounts receivable balance decreases, and cash increases. This boosts available cash.

This dynamic is evident when preparing a cash flow statement using the indirect method. Net income is adjusted for non-cash items, including changes in accounts receivable. An increase in accounts receivable is subtracted from net income, reflecting uncollected cash. A decrease is added back, indicating cash collection from past sales.

Why Accounts Receivable Management Matters

Effective accounts receivable management is important for financial stability. Even profitable companies face liquidity challenges if invoices are not collected timely. Uncollected AR traps cash, limiting a business’s ability to cover immediate obligations.

Timely AR collection improves cash flow, allowing a business to meet operational expenses, invest in growth, or reduce debt. Businesses establish payment terms (e.g., Net 30 or Net 60), expecting payment within 30 or 60 days. Adherence to these terms maintains consistent cash inflow for operations and strategic planning.