Accounts receivable are debts owed to a business for goods provided or services rendered by the business. Leading on from our last blog on Account Payable, we’ll explore the significance, challenges, and strategies surrounding accounts receivable, shedding light on this vital aspect of financial management.

What is the meaning of accounts receivable?

Just as Accounts Payable represents the company’s obligations to its suppliers and vendors, AR represents the amount of money customers owe to a company for goods or services provided on credit, reflecting the anticipated future inflow of funds.

Accounts receivables are considered an asset because it represents payment to be received in the future. It is recorded at the invoiced amount and will be adjusted for necessary allowances, such as doubtful accounts or uncollectible amounts. AR highlights the value of products sold or services rendered, with the understanding that payment will be received later.

As customers make payments, the AR balance is reduced, and the corresponding cash or another form of payment is recorded.

AR is an essential component of accrual accounting, where revenue and expenses are recognised when earned or incurred, regardless of when the actual payment is received. It ensures that the company’s financial records accurately reflect its revenue, even if the cash has yet to be received.

Understanding the Accounts Receivable (AR) Process

The procedure for managing accounts receivable typically starts as follows:

1. A signed agreement between the customer and the company specifies the goods or services to be purchased.
2. The company then fulfils the order by delivering the goods or providing the agreed-upon services.
3. An invoice is sent to the customer, indicating the amount owed and the payment due date.
4. The company records the outstanding amount as a credit entry in accounts receivable, representing the customer’s debt.

Why is accounts receivable an asset?

The essence of accounts receivable as an asset is the expectation that customers’ debts will be converted into cash. Higher receivables indicate a company’s strong potential for generating money and fuelling business growth over time.

A company’s size, nature of the business, regulatory requirements, and management preferences determines the method of accounting employed by the business. Under the cash basis of accounting, revenue is recognised only when cash is received. Therefore, accounts receivable would not be considered revenue under this approach. However, under the accrual basis of accounting, revenue is recognised when earned, regardless of when the cash is received. In this context, AR is indeed considered revenue.

How to calculate Accounts Receivable?

AR can be calculated with the help of a financial ratio known as the Accounts Receivable turnover ratio or receivables turnover. This financial metric assesses how effectively a company manages the credit it extends to customers. It measures the speed at which outstanding debts are collected during a specific accounting period.

In addition to the turnover ratio, the average collection period can be calculated by dividing the days by the AR turnover ratio. This figure helps determine the average days customers take to pay their debts.

Here’s a list of formulas that can be used while calculating AR related Metrics:

• Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

(This ratio measures how efficiently a business collects its average accounts receivable over a specific period. Net Credit Sales represent the total credit sales during that period.)

• Accounts Receivable Turnover Ratio in Days = 365 / Accounts Receivable Turnover Ratio

This calculation determines the average number of days it takes for a customer to pay for credit sales. A lower ratio in days indicates faster collection, while a higher ratio suggests slower payment.

• DSO = (Accounts Receivable / Total Credit Sales) x Number of Days

DSO provides insights into the efficiency of the receivables function. A high DSO indicates delays in receiving payments, while a low DSO suggests prompt payment.

What is the Importance of Accounts Receivables?

Accounts receivable offer several advantages for businesses:

• Improved Cash Flow: AR allow businesses to receive payment for goods or services provided on credit. Businesses can generate sales and revenue by extending credit to customers, even if immediate payment is not received. This improves cash flow and provides a steady stream of incoming funds.
• Increased Sales Opportunities: Offering AR as a payment option can attract more customers and boost sales. Some customers may prefer to buy now and pay later, which can lead to increased purchase volumes and repeat business.
• Customer Relationships and Loyalty: Extending customer credit can help build stronger relationships and foster customer loyalty. Offering favourable payment terms and flexibility can enhance customer satisfaction and encourage long-term business relationships.
• Competitive Advantage: Providing AR as a payment option in competitive markets can differentiate a business from its competitors. It can attract customers who prioritise convenience and flexibility in their purchasing decisions.
• Short-Term Financing: AR can be a short-term financing solution for businesses facing cash flow challenges. Instead of relying on external financing options, businesses can use outstanding invoices as collateral to secure financing or sell them to third-party financing companies at a discount.
• Valuable Business Insights: AR data provides valuable insights into customer behaviour, payment patterns, and creditworthiness. This information can help businesses make informed decisions about credit policies, customer segmentation, and risk management strategies.

What does an Account Receivable Specialist do?

An AR specialist is crucial to a company’s financial operations. Their primary responsibility is to manage the accounts receivable process and ensure the timely collection of outstanding payments from customers. Here are some essential tasks and responsibilities of an accounts receivable specialist:

• Generating accurate and timely invoices for customers.
• Recording and tracking incoming payments.
• Proactively contact customers for overdue payments.
• Reconciling payment discrepancies and resolving issues.
• Communicating with customers regarding billing and payment inquiries.
• Maintaining records of customer accounts and transactions.
• Generating reports on AR status and performance.
• Identifying opportunities for process improvement.
• Ensuring compliance with financial regulations and company policies.
• Supporting audits and financial reviews.

AR Management with Team SBA

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