In the world of business finance, accounts receivable, or A/R, is the term that refers to the money that is held by a business or corporation in exchange for services or products rendered to customers. In essence, it is the invoice that is due and that a business holds in good faith the client will satisfy within an agreed upon time frame.
Receivables fall under a legal framework, and the terms set forth within agreements are binding. Let’s take a closer look at the various facets of receivables and the impact they can have on a company’s bottom line.
A/R is a representation of the credit that is extended to customers. Of course, it should go without saying that most entities will only extend such payment arrangements to clients or customers that have shown to be credit worthy.
Receivable transactions are recorded on a company’s sales ledger. This accounting tool is used to record all of an organization’s sales. It includes such information as the amount of money charged for purchases or services, and it will be used to keep a detailed report of activity that occurs with regard to the customer accounts each month. Each customer’s remaining balance is recorded on the sales ledger at month’s end.
There is usually a team of accountants that oversees a company’s accounts receivable data. The number of team members depends upon the company’s financial resources and overall size. (See: Accounts Receivable: What Small Businesses Need to Know)
In a hypothetical scenario, a company may sell a customer $500 worth of goods and allot them a period of 60 days within which to pay the bill in full. They will send the customer an invoice, resulting in a $500 decrease to its inventory and a $500 credit to its A/R. At the end of the payment period, the customer will ideally fulfill its debt and pay the $500 in full. At this time, the A/R balance is reduced by $500. That $500 then is recorded in the company’s cash column. This is an oversimplified version of events, but it should give you a good idea of how the system works.
A/R’s Effect on Cash Flow
Receivable amounts are also recorded on the balance sheet of a company because they are considered an asset. A/R falls under the category of current assets because it is understood that payment will be received within a year’s time. As account payments are fulfilled, they become a part of an establishment’s positive cash flow, giving the company more working capital to its overall worth. The amount of working capital a business has at any one time is calculated by subtracting the current liabilities from the current assets. A business doesn’t want its A/R to rise too quickly because these transactions are counted against its cash flow until the debts are paid in full.
As you can see, corporate accounting for businesses of all sizes can be a rather complex endeavor. Accounts receivable plays a large role in determining the worth of a corporation.
See also: What is Accounts Payable?