What Type of Account Is Accounts Receivable?
Understand Accounts Receivable's role as a key financial asset and how it impacts your company's balance sheet.
Understanding different account types is fundamental to interpreting a business’s financial information and making informed decisions. This knowledge allows stakeholders to grasp how resources are managed, obligations are met, and revenue is generated.
Understanding Accounts Receivable
Accounts Receivable (AR) represents money owed to a company by its customers for goods or services that have already been delivered or performed but not yet paid for. This typically arises in situations where a business extends credit to its customers, allowing them to receive products or services immediately and pay at a later date. For example, a common payment term like “Net 30 days” means the customer has 30 days from the invoice date to make their payment.
Another common term for accounts receivable is “trade receivables,” referring specifically to amounts owed by customers for sales made on credit. These amounts are usually formalized through invoices, which are delivered to the customer detailing the amount due and the payment timeframe.
Accounts Receivable as an Asset
Accounts receivable is classified as a current asset on a company’s balance sheet. It is considered an asset because it represents a future economic benefit to the company, specifically the expectation of receiving cash from customers who owe money for goods or services already provided. The classification as a “current” asset means that these payments are expected to be converted into cash within one year from the reporting date, or within the company’s normal operating cycle if it is longer than a year.
Accounts receivable is a financial resource that can be converted into cash in the near term, contributing to a company’s short-term liquidity. While it is not yet cash in hand, its value lies in the certainty of its future collection, making it a valuable component of a company’s total assets.
How Accounts Receivable Works
The process of accounts receivable begins when a company sells goods or provides services on credit. After the delivery of the goods or completion of services, an invoice is generated and sent to the customer, detailing the amount due and payment terms. The amount owed is then recorded in the company’s accounting system, increasing the accounts receivable balance.
Businesses monitor these outstanding invoices to ensure timely collection. Common payment terms can range from a few days to 30, 60, or even 90 days. Once the customer makes the payment, the accounts receivable balance decreases, and the company’s cash balance increases. This conversion of receivables into cash is a continuous cycle for businesses that offer credit.
Accounts Receivable on Financial Statements
Accounts receivable is prominently displayed on a company’s balance sheet. Specifically, it is listed under the “Current Assets” section. The balance sheet itself provides a snapshot of a company’s financial position at a specific point in time, showing what it owns (assets), what it owes (liabilities), and the owners’ stake (equity).
The inclusion of accounts receivable on the balance sheet reflects the money the company is expected to collect soon. This makes it an indicator of a company’s short-term financial health and its ability to cover immediate obligations. While the income statement shows revenue generated over a period, the balance sheet provides the specific amount of sales revenue that has yet to be collected in cash at a given date.