What Type of Account Is Accounts Receivable?
Demystify Accounts Receivable: discover its nature as a vital asset, its role in business finance, and how it impacts financial reporting.
Accounts receivable represents the money owed to a business by its customers for goods or services delivered but not yet paid for. This practice allows customers to receive products or services immediately and pay later, typically within 30, 60, or 90 days. It is fundamental for managing a company’s cash flow and sales.
What Accounts Receivable Is
Accounts receivable is classified as a current asset. A current asset is an item of value a business expects to convert into cash, sell, or use within one year or one operating cycle, whichever is longer.
The presence of accounts receivable indicates that a company has made sales on credit. When a business extends credit, it allows customers to delay payment, creating a temporary claim on future cash. This claim results from sales activities, such as selling merchandise or providing services. Managing these balances is important for financial health.
Why Accounts Receivable is an Asset
Accounts receivable is considered an asset because it provides a future economic benefit. The benefit comes in the form of cash the business expects to receive. This future inflow of cash is controlled by the company, which has the legal right to collect the funds.
The right to collect these funds originates from a past transaction, the sale of goods or services. For example, when a landscaping company completes a project for a client and sends an invoice, the amount becomes an account receivable. The company has fulfilled its obligation, and the customer now has a clear obligation to pay.
Accounts Receivable on Financial Statements
Accounts receivable appears on a company’s Balance Sheet, which provides a snapshot of its financial position. It is listed within the current assets section, typically after cash and marketable securities but before inventory. This placement reflects its nature as a liquid asset, expected to be converted into cash soon.
The amount shown for accounts receivable represents the total outstanding balances. While the Income Statement reports revenue from sales, the Balance Sheet shows the portion not yet collected in cash. Accounts receivable acts as a bridge, connecting sales activity to future cash receipts.
How Accounts Receivable Balances Change
The balance of accounts receivable increases when a business makes sales on credit. Each time a product is sold or a service is rendered without immediate payment, the amount owed by the customer adds to the accounts receivable balance. This increase reflects new claims a company has on future cash.
Conversely, the accounts receivable balance decreases when customers make payments. As cash is collected, the corresponding amount is removed from accounts receivable. This process represents the conversion of a credit sale into cash, completing the revenue cycle.