What Is Included in Accounts Receivable?

Accounts receivable is a fundamental concept in business finance, representing money owed to a business by its customers. These amounts arise from the sale of goods or services on credit, meaning the customer received the product or service but has not yet paid for it. Accounts receivable is classified as a current asset on a company’s balance sheet, reflecting the expectation that these amounts will be collected within a typical operating cycle, generally one year. This classification is crucial for understanding a company’s financial health and its ability to convert sales into cash.

Core Elements of Accounts Receivable

Accounts receivable includes amounts due from customers for sales made on credit. When a business delivers goods or provides services and allows the customer to pay at a later date, this transaction creates an account receivable. This means the business has earned the revenue by fulfilling its part of the agreement, but the cash payment is still pending. Services rendered, for which an invoice has been issued but payment has not yet been received, also fall under accounts receivable. For example, a consulting firm that completes a project for a client and sends an invoice for payment will record this as an account receivable until the client pays.

The most common form of accounts receivable is “trade receivables.” These represent money owed to a business by its customers from its normal business operations, such as the sale of goods or services. For instance, a wholesaler delivering goods to a client with payment terms like “Net 30 days” (payment due within 30 days) creates a trade receivable. A retail store offering credit to a regular customer for their purchases would also record the outstanding balance as an account receivable.

Distinguishing Accounts Receivable from Other Financial Items

Understanding accounts receivable is enhanced by differentiating it from other financial items that might seem similar but have distinct characteristics. While accounts receivable represents money owed to the business for goods or services already delivered, other financial items involve different types of claims or obligations.

Notes Receivable

Notes receivable are more formal, involving a written promissory note with specific payment terms, interest rates, and often longer periods, sometimes exceeding one year. Accounts receivable are less formal, typically do not bear interest, and are collected within 30 to 90 days.

Prepaid Expenses

Prepaid expenses are payments made by the business for future goods or services. Examples include paying for a year of insurance or prepaying rent. This is money the business has spent, not money it is owed.

Unearned Revenue

Unearned revenue, also known as deferred revenue, is a liability. This occurs when a business receives payment for goods or services before delivery. The business has an obligation to provide the goods or services, making the received cash a liability until fulfilled. For example, a software company receiving an annual subscription fee upfront records this as unearned revenue until the service is provided.

Cash

Cash is the actual money a business possesses. Accounts receivable is the promise of future cash, not cash itself until the customer pays.

Recognition and Presentation of Accounts Receivable

Accounts receivable is recognized in a business’s financial records under the accrual basis of accounting. This accounting method dictates that revenue is recognized when it is earned, meaning when the goods or services are delivered, regardless of when the actual cash payment is received. This provides a more accurate picture of a company’s financial performance by matching revenues with the expenses incurred to generate them.

The formal recording of an account receivable is typically triggered by the issuance of an invoice. An invoice is a billing document detailing the goods or services provided, the amount owed, and the payment due date. It serves as a formal request for payment and documents the transaction for both the seller and the buyer.

On the balance sheet, accounts receivable is presented as a current asset. This classification signifies that the amounts are expected to be collected and converted into cash within one year from the balance sheet date or within the normal operating cycle of the business. The balance sheet may also present accounts receivable net of an allowance for doubtful accounts, which estimates the portion of receivables that may not be collected. While accounts receivable increases a company’s assets and contributes to reported revenue, it does not represent immediate cash flow until the payments are actually received.