Definition of Accounts Receivable
Accounts Receivable refers to the current asset that is generated when a company does sales on credit. So the money that is yet to be received from the customer is termed as Accounts Receivable and is recorded in the Balance sheet as Current Asset. Accounts receivable shows the credit terms of the company with the customers
Accounts Receivable is an important part of Working Capital. High working capital indicates that the company is selling too much of its product on credit. Accounts Receivable which is too low is also not good as the company is strict on its customers and sells only on cash, which could be difficult on sales.
Accounts Receivable Process
- Step 1: The Company will have to set-up procedure for credit sales. There should be proper checks in place, in order to select customers for credit sales. Not every customer is credit worthy, so correct filtration should be done in order to start credit sales with a particular customer.
- Step 2: Customised bills must be generated by the company with the consent of the customer. If in the future the customer is not ready to pay, then this invoice will be serving as the legal document. All the details regarding the sale should be mentioned in the invoice. A proper mechanism should be in place, which will help the customers to receive the invoice from the company.
- Step 3: Once the bill is generated, the accounting software will record it as sales. As the cash from the transaction is not yet received, so cash will not be debited, instead the accounts receivable will increase. All the sales for which the company has not yet received cash will be recorded as Accounts Receivable under current assets.
Example of Accounts Receivable
Company XYZ has good terms with Mr. X. All the sales that the company makes to Mr X is on credit. The most recent sales is of $40,000. The balance sheet of the company reflects the sales as Accounts receivable for $40,000. The company follows a 90day credit cycle. So all the sales must be converted to cash within 90 days. When Mr X will make the payment within 90days, then the accounts receivable will decrease and cash will increase.
Importance of Accounts Receivable
Accounts receivable helps a company to increase its sales. The most important part of any business is revenue. Accounts Receivable helps to boost the revenue by providing sales on credit. This is an extremely important strategy for any business to survive in the long run. The customers will have to be trust worthy in order to apply for this strategy. Accounts Receivable is considered as the Current asset, which means that the company will rely on Accounts Receivable in order to meet its operating expenses.
Difference between Accounts Receivable and Accounts Payable
Accounts receivable is the money that the customer owes to the business and accounts payable is the money that the business owes to its stakeholders. As the company is doing business on credit, so it is quite natural that the purchases it is making to run the operation should also be on credit. A company is said to be on upper hand when the accounts payable are more than accounts receivable. So it proves that the company is purchasing more in credit than it is selling on credit. Days of Accounts Receivable and days of Accounts Payable are important parameters to be considered when cash conversion cycle is calculated. Cash conversion shows the rate at which a cash is pumped into the business and is recovered by operations.
Advantages of Accounts Receivable
Some of the advantages are:
- Accounts Receivable increases the sales potential of a business. Cash is a scarce asset, so if a business believes only in a cash basis, then they will lose on the opportunity of sales maximization that can be achieved through credit sales. Accounts Receivable shows the capability of credit sales for a company.
- Current assets are liquid assets that can be converted to cash in a short span. So as Accounts Receivable falls under current assets, so it can be used to improve the working capital for a company.
- Low Days of accounts receivable shows the capability of a company to convert its Accounts receivable into cash. This is a good sign and investors can use this positive sign in order to invest in the company.
- Good Accounts Receivable management helps a company to grow. As sales are made on credit, so lot of new customers start trading with the company.
Risks of Accounts Receivable
- The main risk of Accounts Receivable is the risk of customers failing to pay for the purchases. If Accounts Receivable is not recovered, then it will be recorded as debt and the company will incur loss. So too much credit sales is a risk for the company if the customers are not trustworthy.
- At times company do credit sales to known partners in order to increase the sales figure. The Accounts Receivable gets appreciated and the cash is not received ever.
Tips for Collecting Accounts Receivable
- Maintain a proper schedule, which shows the maturity of each Accounts Receivable. The proper triggering system should be set for each maturity of the receivable days
- Proper accounting platforms should be used, which will help to generate proper and prompt invoices for the customers. The invoices should be sent to customers in a timely manner
- Discounts should be offered if payment is made early. This is a very attractive scheme and is being preferred by many customers. Early payment discounts help customers to make timely payments
- Have a diversified range of customers. It is always said that all eggs shouldn’t be kept in the same basket. So if the company has a diversified customer base, then chances of them defaulting all at once are rare.
- Have a good recovery team. If a customer is a wilful defaulter, then there should be a team for money recovery
Accounts receivable is an important current asset that helps to strengthen working capital requirement. Sales are increased with proper management of Accounts receivable. Proper accounting tools and management should be in place in order to maintain Accounts Receivable. A company should be able to draw a line between too high and too low Accounts Receivable.
This is a guide to Accounts Receivable. Here we also discuss the introduction and accounts receivable process along with advantages and importance. You may also have a look at the following articles to learn more –