What Is Accounts Receivable? AR Explained

Accounts receivable (AR) is cash amounts that clients owe your company. The goods or services have been delivered and the invoice sent. Now it’s just a matter of time before you receive payment for a job well done.

If you’ve vetted your customers well and delivered the invoice properly, the money due will flow in as agreed with little or no further action on your part until it’s time to record payments. However, no matter how efficiently you managed the process of extending credit, you may find yourself mired in collection activities. Late payments or nonpayments from customers can cause cash flow problems and lead to difficulty obtaining loans and courting investors. That’s why you need to master the AR process.

What is Accounts Receivable?

Accounts receivable (AR) represents the amount of money that customers owe your company for products or services that have been delivered. AR is listed on the balance sheet as current assets and also refer to invoices that clients owe for items or work performed for them on credit.

Key Takeaways

• Accounts receivable is a current asset on the balance sheet.
• Accounts receivable represents money a company has invoiced for goods or services that have been delivered but not yet paid for.
• Accounts receivable is the flip side of accounts payable, which is money that a company owes to another business for products or services received.

Accounts Receivable Explained

Most businesses provide goods or services before they invoice their clients. The money owed in such a case is called an account receivable. The funds due are recorded as a current asset to offer insight into the financial condition of the company. In accrual-based accounting, AR represents value to the company, even though the money has not come into the company’s possession yet. Accrual-basis accounting recognizes income when it is earned rather than waiting for receipt of payment, as in cash-basis accounting.

Generally speaking, when both parties honor the terms of the transaction, the AR translates into bankable cash. If there is a delay in converting an accounts receivable into payment on the customer side of the transaction, the value of the AR may deteriorate.

While invoices are sometimes lost or misdirected, financial instability, up to and including pre-bankruptcy conditions, is a large reason for customer late payments or defaults—and some companies simply have inefficient process for paying their invoices. This can lead to expensive collection activities and is also why some “pay later” transactions may require credit checks and other risk-mitigation efforts ahead of delivery of goods and services. Payment delays and AR value deterioration typically continue if collection activities are not promptly executed.

Is AR Considered Revenue?

AR is not considered revenue; rather, it is a representation of revenue that has been earned but not yet collected. In accrual accounting, revenue is recognized when it’s earned, regardless of when cash is received. AR is recorded as an asset on the balance sheet, reflecting the amount owed to the company for goods or services already provided. As payments are received, AR decreases and cash increases—but the transaction affects revenue only once.

Why Is Accounts Receivable Important?

Since AR plays such an important role in cash flow management, maintaining an accurate record of accounts receivable is vital for understanding the liquidity of a company as well as its overall financial condition. Credit issuers and potential investors look closely at accounts receivable for financing decisions.

Accounts receivable financing is an arrangement that offers funding based on a portion of accounts receivable. Sloppy AR records could result in difficulty securing accounts receivable financing or a loss of confidence from potential investors.

Accounts Payable vs. Accounts Receivable

Accounts payable and accounts receivable are two sides of the same coin: Accounts payable represents money that a company owes to a supplier for goods or services purchased. Accounts receivable, in contrast, represents money coming in as payment for goods or services delivered with payment terms. AP is considered a liability, and AR is an asset.

For example, if a company orders 50 reams of paper and receives a bill for $300, it would record that expenditure under accounts payable. The office supply company would record the $300 under accounts receivable because it is money the business will receive.

For a company to weather some missed or late payments, it needs a healthy ratio of AR to AP. Typically, a 1:1 AR/AP ratio means that you have just enough money coming in from accounts receivable to cover your expenses. A 1:1 ratio is a risky cash flow scenario because if a client does not pay as agreed, you can’t cover your own bills. This can initiate a spiral of increasing expenses due to late fees or an inability to operate because you can’t pay employees. A healthy business typically has an AR/AP ratio closer to 2:1. At 3:1, there is usually room for savings or reinvestment into the company.

Video: AP vs. AR

Types of Accounts Receivable

Subcategories of accounts receivable can be divided by specific client accounts or to distinguish between types of goods and services. Some businesses also choose to split accounts receivable based on whether the promise to pay was an oral or written agreement. Accounts receivable is part of a larger group of receivables that also include notes receivable and other receivables such as rent receivables, loans, term deposits, and more. There are many types of receivables to account for a vast array of industries and circumstances.

• Notes receivable are amounts your customer owes after signing formal promissory notes to acknowledge the debt.
• Companies in housing or commercial real estate track rent receivables, which are amounts owed by tenants, typically on a monthly basis.
• Any loans to employees or other businesses result in loan receivables.
• If anyone owes your business interest as part of a payment plan, your accountant would record that amount as an interest receivable.

What Is the Accounts Receivable Process?

The accounts receivable process, also known as an AR workflow, is a systematic approach to managing credit sales. It begins with a purchase agreement where terms are set between a client and the company providing the goods or services. This agreement forms the foundation of the AR workflow. Following the agreement, an invoice is issued, and the account receivable is recorded in the company’sbooks.

As the AR workflow progresses, different scenarios unfold. When the account is paid as agreed, it is recorded as a deposit and is no longer a receivable, marking a successful completion of the workflow. If the account is not paid according to the terms of the agreement, the company initiates the next phase of the AR workflow: the collections process.

Steps in The Accounts Receivable Process

1. Before initiating the sale, assess the client’s creditworthiness as part of the AR workflow.
2. Deliver goods or services to your client, as agreed in the purchase agreement.
3. Generate and send an invoice to the customer.
4. Record the invoiced amountas an account receivable in your accounting system.
5. If the client pays as agreed, record the payment as a deposit. This particular cycle of the AR workflow is now complete.
6. If the customer fails to pay, initiate the collections phase of the AR workflow. This may include sending payment reminders, issuing another invoice with any penalties as agreed at the time of delivery (typically 1% to 1.5% per month), or contacting the customer to discuss payment options. If collection efforts have been exhausted, uncollectible accounts should be written off as bad debt.
7. Regular reconcile AR balances and generate reports to analyze the effectiveness of your AR workflow.

Note: When applying late fees, be aware of legal limits. While staying below 10% of the balance due per year is generally safe, but specific regulations vary by state.

Accounts Receivable Payment Terms

Accounts receivable payment terms refer to the date by which the customer agrees to remit payment. The most common payment term is net30, which means the customer agrees to pay the full amount of the invoice within 30 days. The typical range for payment terms is a few days to up to a full year. As customers, some large businesses will insist on net60 or even net90 terms.

Longer payment terms can put a small supplier in a tight spot if it is depending on that money to pay for overhead and other expenses. Cash flow management—control over how much money is coming or going—is one of the most significant factors in the success or failure of a company.

What Is an Accounts Receivable Aging Schedule?

An accounts receivable aging schedule is a report that categorizes a company’s AR according to the length of time an invoice has been outstanding. It typically groups receivables into buckets such as:

• Current (not yet due)
• 1--30 days past due
• 31--60 days past due
• 61--90 days past due
• Over 90 days past due

This schedule helps businesses track which customers owe money and for how long, allowing for more effective collection efforts and cash flow management.

Regularly reviewing the aging schedule can help companies identify payment trends, flag potential bad debts, and take proactive measures to collect overdue payments.

Accounts Receivable (AR) Benefits

In accrual-based accounting, recording accounts receivable is critical to maintaining an accurate picture of a company’s assets on its balance sheet. Poor invoicing practices and AR records could lead to misunderstandings about your company’s cash position, which, in turn, could pose problems in paying expenses, misallocation of funds, audits, and difficulty securing financing or investors. Conversely, well-managed AR can provide a clear picture of expected cash inflows, support better decision-making, and contribute to a company’s financial health and credibility.

Risks of Outstanding AR Balances

Outstanding accounts receivable balances pose several risks to a company’s financial health and operational efficiency. As unpaid invoices age, the likelihood of collection decreases, potentially leading to cash flow problems and increased bad debt expenses. High levels of outstanding AR can strain relationships with suppliers and creditors, especially if the company struggles to meet its own payment obligations. Excessive AR also ties up working capital that could otherwise be used for growth initiatives or day-to-day operations.

From an investor’s perspective, large outstanding AR balances could indicate poor management practices or underlying issues with the company’s customer base—exerting a negative influence on the firm’s valuation and ability to attract future investment.

How to Record Accounts Receivable

AR is listed as a current asset on the balance sheet and included on the income statement as a sale or revenue—the same as goods or services that were paid for immediately. This recording process is fundamental to accrual accounting, where revenue is recognized when earned, regardless of when cash is received. Cash accounting records transactions only when cash changes hands, so AR wouldn’t be recorded until payment is received.

To record AR using the accrual basis of accounting, we can use the following simplified journal entry with hypothetical figures:

When payment is received, the entry would be:

The AR balance can be calculated using this formula:

Ending AR = Beginning AR + Sales on credit – Collections – Write-offs

In the above example, the company has $10,000 in sales on credit. If the same company has a beginning AR of $5,000, $4,000 in collections, and $0 in write-offs, its ending AR would be $11,000 ($5,000 + $10,000 – $4,000 – $0).

No matter what, it’s crucial to regularly reconcile AR to ensure accuracy. This involves comparing the AR subsidiary ledger (which contains individual customer accounts) to the AR control account in the general ledger. Any discrepancies should be investigated and corrected promptly to maintain the integrity of financial statements. While many accounting software systems will automatically compute accounts receivable as the user creates client invoices to simplify bookkeeping, the reconciliation process often requires human oversight and intervention. Even with software that can assist with reconciliation, human oversight is necessary to properly handle nuanced situations.

Accounts Receivable Examples

If Bob’s Plumbing Service visited a client’s office to repair a leak and invoiced the client for that service, Bob’s accountant would record the amount owed as an account receivable on Bob’s balance sheet.

As another example, Susie’s Catering Service delivers 100 box lunches to a recurring monthly company luncheon. Each month, Susie’s company records the total due under accounts receivable after she delivers the goods to her client.

What Is the Accounts Receivable Turnover Ratio?

The accounts receivable turnover ratio is the net credit sales for a given period divided by the average accounts receivable. The AR turnover ratio is used to determine a company’s efficacy at extending and collecting on credit with its clients. A high turnover ratio indicates that a business is more conservative in extending credit or more aggressive in collections. Here is the formula:

AR turnover ratio = Net credit sales / Average accounts receivable

This ratio can be used in conjunction with an allowance account or an allowance for doubtful accounts, which reflects the percentage of accounts receivable expected to be paid, to estimate future cash flow. An allowance account or an allowance for doubtful accounts is a contra asset; that is, it reduces the value of an asset in the general ledger to represent the cash the business expects to collect.

Where the AR/AP ratio demonstrates a company’s sales, the accounts receivable turnover ratio represents the efficiency of collections. With a healthy AR/AP ratio, your business is earning enough to cover expenses—even when clients default or pay late. A higher AR turnover ratio indicates that your business is doing a good job of collecting on invoices.

In essence, accounts receivable are a record of money your customers owe your business for the work or products you have already delivered. Poor record keeping in accounts receivable could lead to problems in audits and bad business decisions due to misunderstandings about cash flow. However, with good invoicing and accounting practices, you will have a clear understanding of your company’s financial health to guide your business strategy, secure financing, or inform potential investors.

What Is Factoring in Accounts Receivable?

In accounts receivable, factoring is a financial transaction where a business sells its outstanding invoices (accounts receivable) to a third party, called a factor, at a discount. This practice, also known as invoice factoring, provides the business with immediate cash while transferring the responsibility of collecting payments from customers to the factor. Factoring helps companies improve their cash flow without taking on debt, but it comes at the cost of receiving less than the full value of their invoices.

Automate AR Ledgers and Accelerate Cash Flow With NetSuite

NetSuite Accounts Receivable is a comprehensive, automated solution that streamlines the entire AR process, from invoicing to payment collection. With the ability to automatically generate and send invoices, apply payments using intelligent matching algorithms, and send customized payment reminders to customers, the platform significantly reduces manual work, minimizes errors, and accelerates the cash collection cycle, allowing businesses to maintain a healthier cash flow.

NetSuite also provides real-time visibility into AR performance through customizable dashboards and reports. These tools offer instant insights into key metrics, such as AR aging and days sales outstanding (DSO), both of which can support a financial team’s ability to proactively manage receivables. And, with features including multicurrency support, integration with various payment gateways, and cash flow forecasting capabilities, businesses can make the informed decisions required to genuinely improve overall working capital management.

The result? A more efficient, accurate, and faster AR process that contributes to improved financial health for the organization.

Accounts Receivable FAQs

What is the job description of accounts receivable?

Accounts receivable professionals manage money owed to the company for goods or services provided on credit. The role requires careful attention to detail, strong organizational skills, proficiency in accounting software, and strong communication abilities. Key duties include:

• Invoicing customers
• Recording and monitoring payments
• Following up on overdue accounts
• Reconciling AR accounts
• Generating financial reports
• Maintaining customer records

Is accounts receivable an asset or a liability?

Accounts receivable is classified as an asset because it represents money owed to the company that is expected to convert to cash within a short period, giving it economic value.

What is another name for accounts receivable?

Another common name for accounts receivable is “trade receivables.” This term is often used in financial statements and accounting discussions to refer to the money owed to a company by its customers for goods or services provided on credit.

In everyday business language, accounts receivable are sometimes simplified to receivables, AR, or even customer accounts.

When does a debt become receivable?

A debt becomes receivable at the moment a company provides goods or services to a customer on credit. This occurs at the point of sale or service delivery, not when the invoice is issued or payment is due.

What happens if someone doesn’t pay their debt?

In the context of accounts receivable, if a customer doesn’t pay their debt, the company typically follows up with reminders. They may also charge late fees and could escalate to collections or legal action. If the debt remains unpaid, it may eventually be written off as a bad debt expense on the business side, impacting the company's financial statements and cash flow.

Where do I find a company’s AR balance?

A company’s accounts receivable (AR) balance can be found on its balance sheet, listed under current assets. For public companies, this information is available in their quarterly and annual financial reports (10-Q and 10-K filings) submitted to the SEC, which are typically accessible through the company’s investor relations website or financial databases.