Accounts receivable represents the amount owed to a business against providing goods/ services to its customers on credit. The credit period often ranges from a few weeks to months and in some cases up to a year. It appears on the balance sheet under the head of current assets.
Understanding Accounts Receivable in Detail
The word receivable refers to the payment that is yet to be received from the client company. Accounts receivables basically represent an extended line of credit provided by a company to its customers and normally have terms and conditions that require payments to be made within a relatively short period of time. Typically, it ranges from a few days to a financial or calendar year.
A business is required to present its accounts receivables on the face of its balance sheet as there is a legal obligation for the customers (with which the accounts receivables amount relates) to pay the outstanding balance to the business. Usually, businesses present accounts receivable in the balance sheet under the head of current assets. This means that accounts receivable from a specific customer is expected to be settled within one year or maybe even less. If a business has receivables appearing on its financials then it means that it has made sales on credit but has not yet received all the money against the sales it has reported in its statement of profit or loss.
Difference Between Accounts Receivable and Accounts Payable
When a business owes balance to its vendors as of the reporting date of its financials then that business would have to present the outstanding supplier balance as accounts payable on the face of its balance sheet under the head of current liabilities. Therefore, it can be said that accounts payable and accounts receivable are polar opposites of each other. To understand the difference between accounts payable and accounts receivable, imagine that company XYZ sends an invoice to company ABC for providing it with cleaning and sanitation services. Now, company ABC would record the aforementioned invoice as expense and accounts payable while company XYZ would record the same invoice as revenue and accounts receivable.
Benefits of Accounts Receivable
Accounts receivable is one of the integral elements used for analyzing a company’s financial position and performance. It is used in measuring a company’s ability to cover its short-term liabilities without any additional cash flows.
Business analysts usually evaluate a company’s accounts receivable in the context of revenue/ turnover by using the accounts receivable turnover ratio. This ratio is basically used for measuring the number of times during a given time period, an entity collects its average accounts receivable. Further analysis of accounts receivable would include calculating days sales outstanding which is used for measuring the average collection period for an entity’s receivable balance over a given time period.
Accounts Receivable Example
A customer of a tyre manufacturing company places an order of 100 tyres. The price of each tyre is $100 each. The company generates an invoice of $10,000 and then sends it to the customer. The company will record revenue and receivable in its books by the above-mentioned amount at the time of delivering the tyres and the invoice to its customer. The company provides its customer with a credit period of 60 days. The amount of $10,000 will appear in the company’s financials until it receives payment from the customer within the aforementioned credit period.
When the customer will pay the company then the company’s accounts receivable would decrease by $10,000 while its bank/ cash would increase by the same amount.