What is accounts receivable?

In bookkeeping and accounting, “accounts receivable” (often abbreviated as AR) refers to the outstanding amounts of money that are owed to a business or organization by its customers or clients for goods or services that have been provided but have not yet been paid for. Accounts receivable represent a company’s right to receive payment and are considered an asset on the balance sheet because they represent future cash inflows.

Here’s how accounts receivable works:

1. Sale of Goods or Services: When a business makes a sale of goods or services to a customer on credit, an accounts receivable entry is created. This entry records the amount owed by the customer and the terms of payment, including the due date.
2. Recording the Transaction: The bookkeeper or accountant records the accounts receivable transaction in the general ledger, typically as a debit to the accounts receivable account and a credit to the appropriate revenue account. This reflects the increase in the asset (accounts receivable) and the corresponding increase in revenue.
3. Collection Process: As time passes and the due date approaches, the business works to collect the outstanding amount from the customer. Once the customer makes the payment, the accounts receivable account is decreased, and the cash or bank account is increased by the same amount. This reflects the conversion of accounts receivable into cash.

Managing accounts receivable effectively is crucial for a company’s financial health. It ensures that the business maintains a steady cash flow and can meet its operational expenses, invest in growth, and pay its own obligations. Key aspects of managing accounts receivable include:

1. Credit Policies: Establishing clear credit policies, including credit limits, terms of payment, and credit checks on customers, helps minimize the risk of non-payment.
2. Invoicing: Timely and accurate invoicing is essential. Invoices should detail the products or services provided, the payment terms, and contact information for payment inquiries.
3. Collection Procedures: Businesses should have effective procedures in place for following up on overdue accounts, which may include reminders, collection letters, and phone calls.
4. Aging Analysis: Regularly analyzing the aging of accounts receivable (categorizing outstanding balances by the number of days past due) helps identify problematic accounts and prioritize collection efforts.
5. Allowance for Bad Debts: Companies often establish an allowance for bad debts, which is a reserve to account for potential uncollectible accounts. This is an accounting estimate that reflects the likelihood of non-payment.

Accounts receivable are a critical component of a company’s working capital, and their management directly impacts cash flow and liquidity. Therefore, businesses must strike a balance between offering credit terms to customers to stimulate sales and ensuring that they collect payments in a timely manner to maintain financial stability.

A bookkeeper for small business can use QuickBooks to analyze financial data, offering valuable insights to the business owner.