Accounts Receivable

What is meant by accounts receivable?

Accounts receivable come into existence when a business offers products or services to its customers on credit. The amount of money that the customers owe to the company is written as an asset on the balance sheet. This asset represents the money that a customer has to pay to the company. For example, a water filtration company supplied pure drinking water to its 100 customers throughout the month, delivering its product without getting paid at the same time. At the end of the month, the company issues invoices for all the customers and they will pay the amount due, usually within 15 or 30 day terms. As this is money owed TO the company not FROM the company, it would be registered as a current asset on the balance sheet.

What are accounts receivable assets?

As discussed above, accounts receivable are the amounts of cash that customers owe to the company for the purchases they made on credit. Accounts receivable are represented in the form of cash equivilants, and given that cash is considered an asset, so too are accounts receivable; additionally they are written as a current asset on the balance sheet because accounts receivable are usually convertible into cash in a short time period (less than twelve months).

However, if the accounts receivable are expected to be paid after more than a year, they will be written as a long-term asset on the balance sheet (but this is a very unlikely situation and those receivables would be secured by promissory notes or other guarantees). Due to several reasons some receivables are never collected or received by a company, The historical unpaid accounts could be helpful to calculate the bad debts provision of the total receivable assets.

Accounts receivable vs accounts payable?

Accounts payable is inverse to accounts receivable. When a business or a company buys something on credit from its suppliers or vendors and owes money to them this amount is known as accounts payable. For example, a software company (X) develops 10 software products for a company (Y) and sends an invoice for their software products to the company (Y). The company (X) will enter the amount in its account receivable column while the company (Y) will write the invoice in its payable column. Accounts payable are considered short-term liabilities and written in the liabilities section of the balance sheet.

What are trade receivables?

The amount of money that the customers owe to the business for the purchase of products or services on credit is defined as trade receivables. Trade receivables and account receivables are two different phrases that usually define the same business terminology (albeit there are account receivables that result from non-trade operations). On the balance sheet, trade receivables are written as current assets to show an amount of cash that will flow from the customers to the company. A business’ receivables are of two types; trade receivables and non-trade receivables. Trade receivables arise from business sales but non-trade receivables are obtained from non-commercial transactions such as insurance returns, the sale of assets on credit or any other credit transaction in which the products or services of the company are not exchanged. Like trade receivables, non-trade receivables are also registered as current assets on the balance sheet.

Importance of financial receivables

Accounts receivable, trade receivables, and non-trade receivables are very relevant to companies because they increase the cash inflow of the company (enhancing the future cash flows). Also, proper management of receivables is of vital importance for the smooth running of a business. Delay in payments from the customers or the late collection of accounts receivable negatively affect the cash flow. On the other hand, proper management of receivables and on-time collections help to improve the cash flow and could help to attract potential investors.

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