What Is Accounts Receivables?
The right of receive money of a firm from customers (individuals or corporations) because the firm had provided customers with goods and/or services on credit but not yet paid for, is known as Account receivables. Accounts receivable is shown in a balance sheet as an asset. Objectives of acccounts receivables are
(i) Growth in sales, (ii) Growth in profits and (iii) Meeting Competition.
According to O.M Joy, “The term receivables is defined as debt owed to the firm by customers arising from sale of goods or services in the ordinary course of business.”
Definition 2
Accounts Receivable (AR) is the amount of money a firm or business owes its customers or clients for goods or services already sold. It is a balance-sheet asset representing the money a company anticipates collecting from its customers in the future.
Understanding the term Accounts Receivables
Accounts Receivable is a critical component of a business's financial management. It assists a company in tracking and managing money due to it, as well as ensuring that its customers pay their bills on schedule. When a business provides goods or services on credit, the customer does not pay immediately but is allowed to pay later, often within 30 to 90 days.
How an Account Receivable Is Created
When a corporation sells goods or services on credit, an account receivable is created. In its accounting system, the sale is recorded as a credit to the revenue account and a debit to the accounts receivable account. This signifies that the revenue from the transaction has been recognized, but the cash has not yet been received.
The consumer is subsequently sent an invoice or bill for the amount owed, along with the credit sales terms, such as the due date and any relevant interest or fees. The customer is anticipated to pay by the deadline. The transaction is documented as a credit to the company's accounts receivable account and a debit to the company's cash account.
The Importance of Collecting AR
AR is directly related to the company's liquidity position. The liquidity ratio refers to the company's ability to meet financial obligations, such as paying debts and bills. It is essential to collect AR because it helps the company to maintain positive cash flow to meet financial requirements while improving financial performance and reducing bad expenses.
- Positive Cash Flow
If a business cannot collect AR, it may face cash flow problems, leading to an inability to meet financial obligations.
- Financial Stability
If the business regularly collects AR, it can reinvest the money elsewhere or repay its debt. This helps the company build a positive relationship with its customers and stakeholders.
- Bad Debt Expenses
Bad debt is when a business cannot collect its due from other parties, such as customers or vendors. The company may need to write bad debts if it fails to contain AR. This leads to significant expenses and impacts badly on profitability. To avoid this, businesses must collect AR timely manner.
Accounts Receivable Example on a Balance Sheet
Let's look at an example of a balance sheet to understand better how accounts receivable work:
|
Current Assets |
Q1 2022 |
Q2 2022 |
Q3 2022 |
Q4 2022 |
|
Cash |
$50,000 |
$60,000 |
$55,000 |
$65,000 |
|
Accounts Receivable |
$25,000 |
$15,000 |
$20,000 |
$10,000 |
|
Other Current Assets |
$40,000 |
$55,000 |
$45,000 |
$50,000 |
In the illustrated table above, the total accounts receivable was $25,000 in Q1 2022. By the end of Q2 2022, the company collected debts of $10,000 from various customers; thus, the accounts receivable were $15,000 in Q2.
In Sentences
- Accounts receivable are the funds due to a firm by its customers for goods or services obtained on credit.
- AR is a valuable asset on a company's balance sheet and an essential part of the company's liquidity position.