What Goes Into a Company’s Accounts Receivable?

Accounts receivable is a fundamental concept in business finance, representing a significant portion of a company’s current assets. It plays a central role in managing cash flow and assessing financial health for many businesses. Understanding accounts receivable is important for anyone seeking to grasp how businesses operate and sustain themselves.

Understanding Accounts Receivable

Accounts receivable (AR) refers to the money owed to a business by its customers for goods or services that have been delivered but not yet paid for. It functions as a legally enforceable claim for payment and is recorded as a current asset on a company’s balance sheet. This classification indicates the company expects to convert these amounts into cash within one year or one operating cycle, whichever is longer.

AR is directly linked to sales made on credit, where a business provides products or services upfront and allows the customer to pay at a later date. This extends a line of credit to the customer, with payment terms typically ranging from a few days to 30, 60, or 90 days, or even up to a year. The company has a reasonable expectation of collecting these funds, making them valuable assets.

Sources of Accounts Receivable

The primary source of accounts receivable for most businesses is trade receivables, which represent the money customers owe for goods or services purchased on credit. For instance, a wholesale distributor selling inventory to a retail store on payment terms creates a trade receivable. Similarly, a marketing agency completing a project for a client and then invoicing them for the service generates a trade receivable.

Beyond typical customer invoices, other common sources contribute to a company’s receivables. Notes receivable are formal, written promises to pay a specific sum, often including interest, over a defined period. They typically arise when a customer needs extended payment terms or when a company lends money, such as an advance to an employee, with a formal agreement for repayment.

Miscellaneous receivables encompass amounts owed that do not fit into the trade or notes receivable categories. Examples include interest receivable from investments, tax refunds due from government authorities, or even claims receivable from insurance companies. They still represent future cash inflows for the business.

Tracking Accounts Receivable

Managing accounts receivable involves a systematic process, beginning when a sale is made on credit. It begins with generating accurate and timely invoices that formally communicate the amount due, payment terms, and due date to the customer. These invoices serve as the foundational documents for tracking the money owed.

Upon invoicing, the amount is recorded in the company’s accounts receivable ledger, which details individual customer balances. This ledger functions as a sub-ledger supporting the overall accounts receivable balance in the general ledger, allowing a business to see what each specific customer owes. Maintaining this detailed record is crucial for monitoring outstanding payments.

The accounts receivable aging schedule categorizes outstanding invoices based on how long they have been unpaid. Common aging categories include 0-30 days, 31-60 days, 61-90 days, and over 90 days past due. This schedule helps businesses identify overdue accounts and prioritize collection efforts, as older receivables have a lower probability of collection.

Accounts Receivable on Financial Statements

Accounts receivable is displayed on a company’s balance sheet, classified under current assets. It is an asset expected to be converted into cash within one year. The balance sheet amount represents the total outstanding invoices owed to the company at a specific point in time.

While accounts receivable is an asset, it is linked to revenue recognition under accrual accounting principles. Revenue is recognized when goods or services are delivered, even if cash is not yet received, with the corresponding amount recorded as an account receivable. This ensures financial statements accurately reflect economic activity regardless of the timing of cash payments.

Investors and stakeholders examine accounts receivable on financial statements to gauge a company’s liquidity and operational efficiency. A healthy accounts receivable balance indicates future cash inflows, important for covering short-term obligations and maintaining working capital. However, excessively high or rapidly increasing accounts receivable might suggest issues with collection processes or customer payment reliability.