What is Accounts Receivable?

Accounts Receivable (AR) is a critical aspect of a company's financial management. It represents the money owed to a business by its customers or clients for goods or services rendered. Essentially, it is the outstanding payments that the company expects to receive. Understanding Accounts Receivable is crucial for businesses as it impacts cash flow, liquidity, and overall financial health.

What Is Included in Accounts Receivable?

Accounts Receivable includes any invoices issued to customers for sales made on credit. This can include sales of products, services, or both. It does not include any cash sales, as those transactions are immediately recorded as revenue. Additionally, Accounts Receivable might include any discounts, returns, or allowances that customers are entitled to but have not yet been deducted from the invoices.

How Does Accounts Receivable Work?

When a business sells goods or services on credit, it creates an Account Receivable entry in its books. This entry represents the amount owed by the customer. The business then follows up with the customer to collect the payment. Once the payment is received, the business reduces the Accounts Receivable balance, and the transaction is recorded as revenue.

Benefits of Accounts Receivable(AR)

Improved Cash Flow: Managing AR effectively ensures that businesses receive payments on time, thereby improving cash flow. This allows businesses to meet their financial obligations, such as paying suppliers and employees, without experiencing cash shortages.

Revenue Recognition: AR allows businesses to recognize revenue when goods or services are delivered, even if payment has not yet been received. This helps in accurately reflecting the financial performance of the business.

Customer Relationships: Efficient AR management can enhance customer relationships. Prompt invoicing, clear communication of payment terms, and timely follow-up on overdue payments can improve customer satisfaction and loyalty.

Reduced Bad Debt: Monitoring AR helps identify and address overdue payments early. By taking proactive measures to collect payments, businesses can reduce the risk of bad debt and write-offs.

Insight into Business Performance: AR aging reports provide valuable insights into the financial health of a business. By analyzing these reports, businesses can identify trends, such as slow-paying customers or declining sales, and take corrective actions.

Improved Efficiency: Automation of AR processes, such as invoicing and payment reminders, can improve efficiency and reduce manual errors. This allows businesses to focus on core activities and improve overall productivity.

Better Financial Planning: Accurate AR records enable businesses to forecast cash flow and plan for future expenses. This helps in making informed decisions regarding investments, expansions, and other financial activities.

Compliance: Proper management of AR ensures compliance with accounting standards and regulations. This is important for maintaining transparency and trust with stakeholders, including investors and regulators.

What Are Examples of Receivables?

Accounts Receivable (AR) are amounts owed to a business by its customers or clients for goods or services rendered on credit. Here are some examples of Accounts Receivable:

Invoiced Sales: When a business sells goods or services to a customer on credit, it creates an Account Receivable for the amount owed. For example, a furniture store sells a sofa to a customer and invoices them for payment within 30 days.

Services Rendered: A consulting firm provides advisory services to a client and invoices them for the hours worked. The amount invoiced becomes an Account Receivable until the client pays.

Subscription Services: A software company offers a subscription-based service to its customers. The company invoices customers for their monthly or annual subscription fees, which are recorded as Accounts Receivable until paid.

Credit Sales: A clothing retailer allows customers to purchase clothes on credit. The amount owed by the customer is recorded as an Account Receivable until the customer settles the debt.

Loan Repayments: A financial institution lends money to individuals or businesses, and the loan repayments are recorded as Accounts Receivable until they are paid in full.

Rentals: A property management company rents out apartments to tenants and invoices them for monthly rent. The rent amount is recorded as an Account Receivable until paid by the tenant.

Utility Bills: Utility companies, such as electricity, water, and gas providers, bill customers for their usage. The billed amount becomes an Account Receivable until paid by the customer.

Insurance Premiums: Insurance companies bill policyholders for their insurance premiums. The premium amount is recorded as an Account Receivable until paid by the policyholder.

What is the Accounts Receivable process?

The Accounts Receivable (AR) process involves managing the credit sales of a business from invoicing to collection.

Here is a typical Accounts Receivable process:

Credit Approval: Before offering credit to a customer, businesses assess their creditworthiness based on factors like credit history, financial stability, and payment behavior.

Sales Order: When a customer places an order, a sales order is generated, specifying the products or services, quantity, price, and terms of sale.

Invoicing: After the products or services are delivered, an invoice is issued to the customer. The invoice includes details such as the amount owed, payment terms, and due date.

Recording Sales: The sales transaction is recorded in the accounting system as revenue and an Account Receivable is created for the amount owed by the customer.

Payment Terms: Payment terms specify when the payment is due. Common terms include net 30 (payment due in 30 days), net 60, and net 90.

Payment Collection: Businesses follow up with customers to collect payments. This may involve sending reminders, statements, or making collection calls.

Cash Application: When the customer makes a payment, the payment is applied to the respective invoice(s) in the accounting system to clear the Account Receivable.

Aging Analysis: Regularly reviewing aging reports helps identify overdue invoices. This allows businesses to take timely action to collect overdue payments.

Bad Debt Management: If a customer fails to pay, the Account Receivable may be considered bad debt and written off as a loss.

Reconciliation: Periodically, the Accounts Receivable ledger is reconciled with customer payments to ensure accuracy.

Reporting: AR reports provide insights into the financial health of the business, including the average collection period, outstanding balances, and aging analysis.

Credit Policy Review: Regularly reviewing and updating credit policies helps ensure that credit is extended wisely and risks are minimized.

How to Record Accounts Payable?

Recording Accounts Payable (AP) involves documenting the amounts owed by a business to its suppliers or vendors for goods or services received on credit. Here's how to record Accounts Payable:

Invoice Received: When a supplier provides goods or services, they typically send an invoice detailing the amount owed, payment terms, and due date.

Enter Invoice into Accounting System: Record the invoice in the accounting system. Include information such as the supplier name, invoice number, invoice date, due date, and amount.

Credit Accounts Payable: Create a credit entry in the Accounts Payable account to reflect the amount owed to the supplier. This increases the Accounts Payable balance.

Debit Expense Account: Depending on the nature of the transaction, debit the appropriate expense account (e.g., inventory, utilities, or services) to reflect the cost incurred.

Payment Terms: Payment terms specify when the payment is due. Common terms include net 30 (payment due in 30 days), net 60, and net 90.

Payment: When the payment is made to the supplier, reduce the Accounts Payable balance by crediting the Accounts Payable account and debit the Cash account to reflect the payment.

Reconciliation: Periodically reconcile the Accounts Payable ledger with supplier statements to ensure accuracy and identify any discrepancies.

Reporting: AP reports provide insights into the business's liabilities, outstanding balances, and payment history, which are essential for financial analysis and decision-making.

Recording Accounts Payable accurately is crucial for maintaining good relationships with suppliers, managing cash flow effectively, and ensuring compliance with financial reporting requirements.

Impact of Accounts Receivables on Financial Statements

Balance Sheet:

• AR is recorded as an asset on the balance sheet, representing the amount of money owed to the company by its customers for goods or services provided on credit.

• An increase in AR will lead to an increase in total assets, which can improve the company's liquidity ratio but also indicates that more cash is tied up in AR.

Income Statement:

• Revenue is recognized on the income statement when goods are delivered or services are performed, even if payment has not yet been received. This is based on the revenue recognition principle.

• AR does not directly impact revenue on the income statement, but it indirectly affects cash flow and profitability.

Cash Flow Statement:

• AR affects cash flow from operating activities on the cash flow statement. An increase in AR means that less cash is received from customers for sales made on credit, which reduces cash flow from operations.

• Conversely, a decrease in AR (such as when customers pay their invoices) will increase cash flow from operations.

Bad Debt Expense:

• If a company estimates that a portion of its AR will not be collected, it may record a bad debt expense on the income statement. This expense reduces net income and reflects the expected losses from uncollectible accounts.

Aging Reports:

• AR aging reports provide insights into the financial health of a company by categorizing AR based on the length of time invoices have been outstanding. This helps management assess the effectiveness of credit and collection policies.

How Are Accounts Receivable Different From Accounts Payable?

Definition:

Accounts Receivable (AR): AR represents the money owed to a company by its customers or clients for goods or services provided on credit. It is an asset on the company's balance sheet.

Accounts Payable (AP): AP represents the money owed by a company to its suppliers or vendors for goods or services received on credit. It is a liability on the company's balance sheet.

Nature:

Accounts Receivable (AR): AR arises from sales made on credit, where the customer is invoiced for the goods or services and is expected to pay at a later date.

Accounts Payable (AP): AP arises from purchases made on credit, where the company receives goods or services from a supplier and is invoiced for payment at a later date.

Impact on Financial Statements:

Accounts Receivable (AR): AR is recorded as an asset on the balance sheet and affects the company's liquidity and financial health. It also impacts the income statement, as revenue is recognized when sales are made on credit.

Accounts Payable (AP): AP is recorded as a liability on the balance sheet and reflects the company's obligations to its suppliers. It does not directly impact the income statement unless there are expenses related to AP, such as interest on overdue payments.

Management:

Accounts Receivable (AR): Managing AR involves ensuring timely payment from customers, monitoring aging reports, and following up on overdue payments to minimize bad debt.

Accounts Payable (AP): Managing AP involves ensuring timely payment to suppliers, taking advantage of discounts for early payment, and maintaining good relationships with vendors.

Does accounts receivable count as revenue?

No, accounts receivable (AR) does not count as revenue. AR represents the amount of money owed to a company by its customers for goods or services that have been delivered but not yet paid for. Revenue, on the other hand, is the amount of money earned by a company from its primary business activities, such as selling goods or providing services. Revenue is recognized when goods are delivered or services are performed, regardless of when payment is received. AR is recorded on the balance sheet as an asset, while revenue is recorded on the income statement.

Accounts Receivables Best Practices

1. Establish Clear Credit Policies: Define credit terms, such as payment due dates, late payment penalties, and credit limits, to set clear expectations for customers.

2. Perform Credit Checks: Conduct credit checks on new customers to assess their creditworthiness and reduce the risk of late or non-payment.

3. Send Invoices Promptly: Invoice customers promptly after delivering goods or services to accelerate the payment process.

4. Offer Multiple Payment Options: Provide customers with various payment methods, such as online payments, credit cards, and electronic funds transfer (EFT), to make it easier for them to pay.

5. Monitor Accounts Receivable Aging: Regularly review aging reports to track overdue payments and take timely action to collect them.

6. Follow Up on Overdue Invoices: Send reminders and follow-up emails or calls to customers with overdue payments to encourage timely payment.

7. Provide Discounts for Early Payment: Offer discounts for early payment to incentivize customers to pay promptly and improve cash flow.

8. Establish a Collections Process: Develop a collections process for handling severely overdue accounts, including escalation procedures if necessary.

Accounts Receivable Automation

Accounts receivable (AR) automation is the process of using technology to streamline and automate repetitive tasks involved in managing accounts receivable. This can include tasks such as:

• Generating invoices

• Sending email reminders and statements

• Accepting online payments

• Reconciling payments

• Chasing overdue invoices

Benefits of Accounts Receivable Automation

1. Faster Payment Processing: Automation accelerates the processing of invoices and payments, reducing the time it takes to receive payments from customers.

2. Improved Cash Flow: By speeding up payment processing, automation helps businesses maintain a steady cash flow, reducing the need for short-term borrowing or other financing options.

1. Reduced Errors: Automation minimizes the risk of human errors associated with manual data entry, leading to more accurate financial records and fewer payment discrepancies.

2. Enhanced Customer Relationships: Automation allows businesses to send timely payment reminders and notifications, improving communication with customers and reducing the likelihood of late payments.

3. Cost Savings: By reducing the need for manual processing and paper-based invoicing, automation can lower administrative costs and improve overall efficiency.

4. Better Visibility and Reporting: Automation provides real-time visibility into AR processes, allowing businesses to track payment status, analyze payment trends, and generate detailed reports for better decision-making.

How does AR Automation work?

AR automation software can be integrated with your existing accounting system. This allows the software to automatically capture data from your sales and accounting systems. The software can then use this data to automate a variety of AR tasks.

For example, the software can automatically generate invoices when a sale is made. It can then send these invoices to customers electronically. The software can also send automatic email reminders to customers when their invoices are due.

When a customer makes a payment, the software can automatically reconcile the payment with the corresponding invoice. This eliminates the need for manual data entry and reduces the risk of errors.

There are a number of AR automation software solutions available on the market, so you'll need to shop around to find a solution that meets your needs.