Accounts receivable

Definition

Accounts receivable refers to the outstanding amounts that a business has yet to collect from its customers or clients for goods sold or services provided on credit. It represents the short-term financial obligations owed to the company.

What is accounts receivable?

Accounts receivable com from credit transactions where a company provides goods or services to customers with an agreement for deferred payment. When a business extends credit to customers, it essentially allows them to defer payment for a later date, creating an accounts receivable.

In financial statements, accounts receivable are recorded as assets on the balance sheet. They represent a claim that the company has on the payment from its customers. Furthermore, accounts receivable impact a company’s working capital. While they are assets, a high level of receivables may indicate potential liquidity issues.

Businesses closely monitor their accounts receivable to ensure timely collection. This involves tracking overdue payments, sending reminders or statements to customers, and implementing collection strategies if necessary.

Recognising that not all accounts receivable may be collected, companies often establish a provision for bad debts. This is an estimate of the portion of receivables that may not be collected due to customer defaults.

Analysts and investors may assess a company’s accounts receivable revenue ratio to evaluate how quickly it is collecting outstanding payments. A high revenue ratio is generally favourable, indicating effective credit management.

Accounts receivable vs. accounts payable

Accounts receivable and accounts payable are key components of a company’s financial operations. Accounts receivable represents money owed to the company by its customers for goods or services provided on credit, reflecting potential future cash inflows. Accounts payable, on the other hand, represents money the company owes to its suppliers for goods or services received, indicating future cash outflows.

Example of accounts receivable

1. Service provided on credit:
   • On March 1st, ABC Services provides consulting services to a client, XYZ Corporation, and invoices them for £8,000. The payment terms are net 30 days, meaning XYZ Corporation has 30 days to pay the invoice.

   The accounting entry for this transaction is:

   $\text{Accounts receivable}(Asset)=\; \pounds 8,000$

   $\text{Service revenue}(Revenue)=\; \pounds 8,000$

   This entry reflects an increase in the accounts receivable asset, representing the amount owed by the client, and an increase in service revenue.

2. Payment within Credit Terms:
   • On March 25th, within the credit period, XYZ Corporation makes a payment of £8,000 to ABC Services.

   The accounting entry for the payment is:

   $\text{Cash}(Asset)=\; \pounds 8,000$

   $\text{Accounts receivable}(Asset)=\; \pounds 0$

   This entry reduces the accounts receivable and increases the cash asset to reflect the payment received.

In this example, accounts receivable initially represent the amount owed to ABC Services by its client for services rendered. The asset is later reduced when the payment is received within the specified credit period.