Accounts receivable is incoming cash that is owed to a business.
Typically, the money coming into the business is paid after the company extends credit to a customer in exchange for the purchase of products or services. The credit period is at the discretion of the business, but usually ranges from several days to several months - even often up to a year,
The term "accounts receivable" is the financial account a company uses to keep tabs on credit owed by customers and when it gets paid. Any activity (or "entries") made into the account are called receivables.
For example, a landscaping company may mow a customer's lawn, trim the hedges, and plant a few bushes. When the work is complete, the company will create a bill. The amount of money owed for the landscaping services represents the accounts receivable, which sets the terms, through the invoice, in when the payment is received.
When evaluating accounts receivable, give proper weight to the difference between gross and net accounts receivable, as well. Gross accounts receivable is the total assets included on a company's balance sheet. Any unpaid bill or bad bet is the net accounts receivable, or the new total value of a company's accounts receivable, when including the unpaid debt that is deemed to be uncollectible.
Accounts Receivable Models
To document any accounts receivable, create an invoice (see below) which details the products or services your business provided to a customer, the amount owed for that product or service, including any sales taxes and extra fees (like for shipping a product) and the due date for payment.
Before you do that, though, it's important to know the distinctions between the two main accounts receivable models: cash basis accounting and accrual basis accounting.
Cash basis accounting
When using a cash basis of accounting model, you record the transaction directly into your company's accounting record's systems once payment is accepted.
Accrual basis accounting
Unlike cash basis accounting, where payments are recorded when the money is received, accrual basis of accounting records revenues when the money is earned by a company. With accrual basis accounting, you record any income as soon as the invoice is sent and not when the invoice is paid out. This accounting system is widely used by companies.
How to Record Accounts Receivable
To properly record accounts receivable, generate an invoice, then proceed with the following three key steps:
Step 1: Send the invoice
Send an invoice immediately after providing a customer a product or service. You'll need the invoices to keep account ledgers accurate and up to date.
Step 2: Track the invoice
Check for the payment on a weekly basis. If it doesn't arrive, send the customer a reminder.
Step 3: Receive and record payment
When you receive the payment, record it as "paid" and enter it into your accounts receivables ledger. Make sure your customer records are matched squarely with your financial ledgers. In the accounts receivable world, it's vital to monitor who's paying you and when they're paying you.
Accounts Receivable Turnover Ratio
The accounts payable turnover ratio, also known as the receivable turnover ratio, is the measurement of how well a company handles cash receivables. In general, the higher the ratio, the more capable you are in handling those receivables. Conversely, the lower your accounts receivable turnover ratio, the worse you're handling cash receivables.
The formula for calculating your accounts receivable turnover ratio is fairly straightforward. Simply divide the net credit sales over a specified period by the average account receivables. The formula for calculating average accounts receivable is fairly basic, too. Just add the value of accounts receivable at the start of the specified period of the desired period to their value at the end of the period. Then simply divide the sum total by two. (Meaning, to find the average you have to add the two numbers - opening and closing - and divide by 2.)
While the account receivable turnover ratio is usually calculated once per year, some companies run the numbers more often - usually on a quarterly or even a monthly basis.
Is Accounts Receivable an Asset or a Liability?
Accounts receivable is an asset, as it both represents the amount owed by the customer to a business, and is convertible to cash at a future time. On most company balance sheets, accounts receivable ledger items are recorded as an asset, as the asset will convert to cash within one year.
There are several reasons why account receivables are viewed as credits not debits. One primary reason is that, as an asset, companies can borrow against the cash owed, for multiple purposes (to buy more equipment, pay their own bills or to pay worker salaries, for example.)
The problem occurs when an invoice isn't paid, and the asset can not stay recorded as a receivable.
Remember that financial assets are deemed as having economic value, and can be expressed, in accounting terms, as cash. But if the invoice goes unpaid, and the assets don't materialize, companies "write off" the bad debt to a different company financial account (usually a company's expense account) where it can be recorded as a business expense for tax purposes.
Accounts Receivable vs. Accounts Payable
Comparing and contrasting accounts receivable versus accounts payable is really a matter of good accounting principles.
When a business owes money to another business, that debt is deemed as accounts payable - it's money coming out of the payers' account at a future date. That's the direct opposite of accounts receivables, where money is expected to come into a company's account, and not leave it.
For example, Company #1 provides a cleaning service for Company #2, and submits an invoice for payment. Company #2 has a debt to Company #1, so it includes the payment bill in its account payables ledger. Company #1, on the other hand, is expecting payment on the bill, and thus records it in its account receivables ledger.
Accounts receivable is a critical component in a company's financial management practices. Know how it works, and use accounts receivable to keep a close eye on your company's bottom line.