Accounts Receivable

What is Accounts Receivable?

Accounts receivable show how much customers owe a corporation. It records pending payments of clients buying on credit and is recorded in the Balance sheet as a Current Asset. It shows the credit terms of the company to the customers.

Table of contents

• What is Accounts Receivable?
• Explanation
• Process
• Formulas
• How to Calculate? – Example
• Importance
• Journal Entry – Credit & Debit
• AR Aging
• Notes Receivable vs. Accounts Receivable
• Accounts Payable vs. Accounts Receivable
• Jobs & Duties
• Conclusion
• FAQs
• Recommended Articles

Key Highlights

• When a business sells on credit, it records the pending payments as accounts receivable. On the other hand, accounts payable tracks the amount the company owes to suppliers.
• By allowing sales on credit, a firm can increase income, an essential tactic for any company looking to survive over the long term.
• The primary risk is that buyers may not pay for their goods. If the company cannot recover the amount, they record it as a debt, and the corporation suffers a loss.

Explanation

It displays the firm’s credit terms to its clients. As it adds value to the organization, it is an asset listed in the balance sheet’s current assets. It represents a corporation’s credit line, which conditions that customers make payments within a specific time frame. It may take a few days, months, or a year.

Customers are legally required to pay the loan. It is a liquid asset that is an essential part of Working Capital. High working capital indicates that the company sells too much of its product on credit. On the contrary, if it is too low, it depicts the company dealing primarily in cash, which can be difficult for sales.

Accounts Receivable Process

Step 1: Initiate a Procedure

• The company first needs to set a proper approach for credit sales.
• Not every customer is creditworthy, so the company requires correct filtration to select trustworthy customers.
• Lay down necessary credit policies like the credit limit, payment time, interest rates, etc.

Step 2: Generate and Track

• The company must generate customized bills with the customer’s consent. Thus, if the customer does not pay in the future, this invoice will serve as the legal document.
• The invoices should contain all details regarding the sale, and a proper mechanism for sending the invoice should be in place.
• The AR officer must keep track of all invoices the company sends and the payments that customers make.

Step 3: Accounting

• At the generation of bills, the accounting software records them as sales.
• If the company does not receive the cash, they won’t debit it; instead, they will increase the receivables.
• They also need to create a journal entry for any bad debts.

Journal Entry – Credit & Debit

Companies manage AR debtor-wise for sales data and dues. They are crucial as they constitute the foundation of the company’s financial performance.

• During the first journal entry after an on-credit sale, companies debit the AR account while crediting the sales account.
• When the customer makes the payment, there is a journal entry for debit on the cash account and credit on the AR account.
• Some companies offer discounts to customers who pay before a specific date. For that matter, the sales discount and cash account is in debit, and the AR account is in credit.
• The business understands that when processing credit transactions, not all of its customers will make payments. As a result, the company may occasionally suffer losses known as bad debts.
• There are two ways to record bad debt costs: the direct write-off approach and the allowance technique.
• In direct write-off, the company debits the bad debt account while crediting the AR account. They debit the allowance account rather than the bad debt account in the allowance method.

Example:

Let us see an example of how to make journal entries.

Download the Excel template here

Company A made a sale of $60,000 to Mr. X on credit on 25th August 2022. Mr. X has to pay the amount within 90 days, i.e., by 25th November 2022.

The first journal entry for the sale will be,

Now, we have three possibilities,

• Mr. X pays the amount before/on time.

• Mr. X pays a fraction of the amount on 25th September and another fraction on 25th October, making the final payment on 25th November.

• Mr. X makes the full payment by 10th September. Therefore, they get a 7% discount.

• For some unavoidable reason, Mr. X cannot make the full payment. Therefore, it will be bad debt. Using the write-off method, the journal entry will be,

• For some unavoidable reason, Mr. X can only pay if he recovers financially. Therefore, using the allowance method, the journal entry will be,

Accounts Receivable Formulas

Average Accounts Receivable

• To calculate the average AR, total the opening and closing balance and divide it by two.
• The companies must note the balances over a period. It could be monthly, quarterly, or annually.
• Formula: Average Accounts Receivable = (Opening Balance + Closing Balance)/ 2

Accounts Receivable Turnover Ratio

• This ratio calculation includes dividing net credit sales by average AR.
• It indicates a business’s management regarding debt collection.
• Formula: Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable.

How To Calculate Accounts Receivable? – Example

Download the Excel template here – Accounts Receivable Excel Template

Example 1

Mr. X purchases goods from Company A majorly on credit. The most recent sales are $65,000. Mr. X pays $20,000 right away, keeping the rest on credit. As the company follows a 90-day credit cycle, it will convert the sales to cash. Calculate the accounts receivables.

Given,

Apply the formula.

Accounts receivable are $45,000. The amount reduces from the accounts if paid within 90 days; otherwise, it’ll count as bad debt.

Example 2

Company A makes credit sales of $1,720,000. The returns they receive are $370,000. They recorded the accounts receivable as $460,000 and $940,000 at the start and end of the year, respectively. Calculate the turnover ratio to determine how often the company can collect the receivables.

Given,

First, let us calculate the net credit sales.

Net Credit Sales = Credit Sales – Returns.

Next, we calculate the average account receivable.

Average Account Receivable = (Closing Balance + Opening Balance) / 2

Here is the turnover ratio calculation,

As the turnover ratio is 2, the company can collect receivables twice a year.

Accounts Receivable – Importance

• The essential part of any business is revenue. It helps companies boost revenue by providing sales on credit.
• It is a crucial strategy for any business to survive in the long run. However, the customers will have to be trustworthy to apply this strategy.
• A solid AR policy allows cash flow planning, which results in no need for repeated follow-ups with clients. Thus, saving the organization’s valuable time, money, and effort.
• It can occasionally assist the business in getting good deals.
• Shareholders can use it to assess the firm’s effectiveness in collecting money.

AR Aging

• Companies record receivables in AR aging reports according to how long a payment has been unpaid.
• The columns usually contain date periods of thirty days each. They display receivables that are due now and those that are already late.
• The aging report is beneficial in outlining credit and marketing strategies as a result. It is a yardstick for evaluating a firm’s clientele’s stability and financial standing.

Notes Receivable vs. Accounts Receivable

Notes Receivable

• It is a budget item on the balance sheet that represents unpaid debts owed by customers.
• These items include the interest charges.
• These can be current or non-current assets depending on when the client pays or may pay their promissory note.

Accounts Receivable

• It is a budget item displayed as assets on the balance sheet.
• It keeps track of the cash a client owes the firm but has not yet paid.
• These items do not include any interest charges.
• The presumption that the client will repay the debt within a year makes these items assets.

Accounts Payable vs. Accounts Receivable

Accounts Payable

• It is the money the business owes to its stakeholders, creditors, suppliers, etc.
• A company has the upper hand when the accounts payable are more. It proves that the company is purchasing more in credit than it sells.
• A rise indicates an influx of money. Besides, a decrease reflects cash outflow.

Accounts Receivable

• It is the money the customer owes to the business.
• A rise indicates a cash outflow since more clients have made credit payments, which means the company has less available cash.
• A decrease in these accounts indicates an increase in cash flow.

Accounts Receivable – Jobs & Duties

With knowledge about accounts receivable and a few necessary skills, one can opt for the following jobs. Given are the duties and salaries for the notable job options.

Specialist

• They are responsible for collecting the company’s and customer’s accounts information.
• Additionally, they need to make sure the company follows the spending policies.
• Salary: $46,594 per annum.

Analyst

• They monitor, record, and review all account activities regarding debt collection.
• They are also responsible for resolving issues like debt repayment through customer interactions.
• Salary: $51,467 per annum.

Supervisor

• They manage all responsibilities related to the accounts, from billing charges, auditing, and reporting to invoices and collections.
• They must plan and arrange meetings for policy review. They also provide staff training.
• Salary: $56,815 per annum.

Conclusion

It is an essential current asset that helps strengthen working capital requirements. Right accounting tools and management should be in place for their maintenance. Therefore, with proper management, sales can increase. However, a company should be able to draw a line between too high and too low receivable values.

FAQs

1. What is Accounts Receivable?

Answer: Accounts receivable are balance sheet assets showing the money customers owe to a business. They reflect the company’s credit terms to its customers. Customers are required to pay in cash within a year.

2. What happens when clients do not pay the credit they owe?

Answer: Accounts receivable are written off as a bad debt or one-time cost when it becomes evident that a client won’t pay the credits.

3. Are accounts receivable assets or liabilities? Do they count as revenue?

Answer: The current assets column of a balance sheet contains the receivable information. In cash-basis accounting, only operations that result in the payment or receipt of cash count as revenue. Therefore, accounts receivable is not revenue account.

4. How to prepare an audit for accounts receivable?

Answer: Companies must audit their AR account to maintain accuracy. Initially, they must acquire an accounting system facilitating the creation of invoices and transaction data. After that, they must collect payments, update the status of cleared invoices, and maintain a record of receivables and refunds. Finally, they should reconcile their financial accounts. 

Recommended Articles

This is a guide to Accounts Receivable. Here we define it, its process, journal entry, aging reports, formulas, and calculations. Visit the following articles to learn more,

1. Accounts Payable Cycle
2. Nostro Account
3. Accounts Payable Cycle
4. Accounts Receivable Process