What Is Accounts Receivable in Accounting?

Accounts receivable (AR) represents money owed to a business for goods or services that have been delivered but not yet paid for. This financial asset appears on a company’s balance sheet, signifying funds the business expects to collect. Accounts receivable is a fundamental indicator of a business’s financial health and its ability to manage its incoming cash.

Understanding Accounts Receivable

Accounts receivable arises primarily from sales made on credit, where a business provides products or services to customers with an agreement for payment at a later date. This represents a promise of future payment rather than immediate cash. Accounts receivable is classified as a current asset on the balance sheet because these amounts are generally expected to be converted into cash within one year or less. This contrasts with cash sales, where payment is received instantly, and with accounts payable, which represents money a business owes to others.

The presence of accounts receivable is a significant component of a company’s working capital, which is the difference between current assets and current liabilities. Effective management of accounts receivable directly influences a business’s ability to fund its daily operations. Businesses often establish credit terms with their customers, such as “Net 30,” meaning the full invoice amount is due within 30 days from the invoice date. Other common terms might include “Net 60” or “Net 90,” or offer early payment discounts like “2/10 Net 30,” which provides a 2% discount if paid within 10 days, with the full amount due in 30 days.

The Accounts Receivable Cycle

The accounts receivable cycle begins when a business delivers goods or services to a customer on credit. Once the transaction occurs, an invoice is created and issued to the customer, detailing the amount owed, the goods or services provided, and the payment terms.

Following invoicing, the business records the sale and the corresponding accounts receivable in its accounting system. The next step involves diligently tracking payment due dates and monitoring outstanding balances. Businesses aim to collect all outstanding invoices before they become overdue to maintain a healthy cash flow.

The cycle concludes with the collection of customer payments. Once payment is received, the funds are processed and applied to the customer’s account, reducing the outstanding accounts receivable balance. If a customer challenges a bill or refuses to pay, the cycle may also include steps for dispute resolution and, in some cases, writing off uncollectible debts.

Recording Accounts Receivable

Accounts receivable is recorded in a company’s general ledger using the double-entry bookkeeping system. When a sale is made on credit, the accounts receivable account is debited, increasing the amount owed to the business, and the sales revenue account is credited, recognizing the income earned. For example, if a business sells $1,000 worth of goods on credit, it debits Accounts Receivable for $1,000 and credits Sales Revenue for $1,000.

When the customer pays the outstanding amount, the cash account is debited, increasing the company’s cash balance, and the accounts receivable account is credited, reducing the amount owed. If a customer returns goods or receives an allowance, this also impacts accounts receivable, typically by crediting Accounts Receivable and debiting a Sales Returns and Allowances account.

Businesses must also account for bad debt expense, which represents the portion of accounts receivable unlikely to be collected. This is recorded by debiting Bad Debt Expense, an operating expense, and crediting an Allowance for Doubtful Accounts, a contra-asset account that reduces the net value of accounts receivable on the balance sheet.

Accounts receivable appears on the balance sheet as a current asset, reflecting money expected within one year. Sales revenue, from which accounts receivable originates, impacts the income statement. Cash collections from accounts receivable are reflected in the operating activities section of the cash flow statement, showing the actual cash inflow.

Managing Accounts Receivable

Effective management of accounts receivable is important for maintaining a business’s financial health and cash flow. This begins with establishing clear credit policies that define terms, such as payment due dates and any early payment discounts, and involve vetting customers for creditworthiness. Implementing proper credit checks helps assess risk before extending credit.

Accurate and timely invoicing practices are fundamental to efficient accounts receivable. Invoices should clearly state payment instructions and terms to minimize disputes and accelerate the collection process. Many businesses utilize automated systems to generate and dispatch invoices, which can reduce errors and improve efficiency.

An aging schedule is a tool for managing accounts receivable, which categorizes outstanding invoices by the length of time they have been unpaid, typically in intervals like 0-30 days, 31-60 days, and 90+ days. Analyzing this schedule helps businesses identify overdue accounts and assess the likelihood of collection. The longer an invoice is past due, the higher the risk it becomes uncollectible.

Collection strategies involve systematic follow-up on overdue payments, which can include automated reminders via email or SMS, and personal calls. Some businesses implement tiered reminder systems, increasing urgency as the payment becomes more overdue. For accounts deemed uncollectible, businesses may formally write off the bad debt, impacting financial records. This process helps ensure that financial reporting remains accurate regarding expected cash inflows.