What is Accounts receivable?
Accounts receivable definition
- Accounts receivable (AR) is an asset account in a company's general ledger that represents the amount of money customers owe the company for products or services sold on credit. It is the opposite of accounts payable, which represents the amount of money a company owes to its suppliers or vendors for purchases made on credit.
- When a company sells products or services on credit, it creates an accounts receivable entry in its accounting system. The entry shows the amount of the sale, the name of the customer, and the payment due date. The accounts receivable balance represents the total amount of money that customers owe the company.
- Accounts receivable management is crucial to a company's cash flow. Effective management reduces the amount of time it takes for the company to collect payment from customers. It also increases the likelihood of receiving payment in full while reducing the risk of bad debt.
- AR can be managed by tracking it efficiently, following up with customers who haven't paid, and setting up a clear payment policy to ensure customers pay their bills on time. In addition, companies can set up payment reminders for customers and offer discounts for early payment to encourage customers to pay promptly.
- Accounts receivable is a fundamental part of a company's financial management system, and managing it well can help improve cash flow, strengthen customer relationships, and ensure the long-term health of the business.
Here are some additional things to know about accounts receivable:
- Factoring: Companies can factor their accounts receivables to improve their cash flow. Factoring involves selling accounts receivable to a third-party company for a percentage of their value, also called a discount. The third-party then assumes responsibility for collecting the debt, and the company gets immediate cash.
- Aging Reports: Aging reports are used to monitor accounts receivable. These reports provide a detailed analysis of how long customers have owed the company money. The report helps companies identify the aging of their accounts receivable, which can be used to create a plan to collect overdue debt.
- Bad Debt Expenses: Sometimes, customers are unable or unwilling to pay their bills. In such instances, companies write off the amount as a bad debt expense. This expense is recognized as a loss on the company's income statement and reduces accounts receivable and net income.
- Allowance for Doubtful Accounts: Since some customers may be unable or unwilling to pay their debts, companies need to estimate how much of their accounts receivable may become uncollectible. The allowance for doubtful accounts is an estimate of the amount that may be uncollectible, and it is recorded as a contra asset account.
- Collection Efforts: Sometimes, customers can have difficulty paying their bills on time. Consistent and clear follow-up and collection efforts, such as sending invoices at specific intervals, sending reminder notices, and making collections calls can help improve the collection of accounts receivable and reduce bad debt expenses.
Effective management of accounts receivable can help companies maintain a healthy cash flow, minimize bad debts, and ensure that customers pay their bills on time.
