What is Account receivable? And Why do we need it?

account receivable

account receivable

A company gets an order of 5000 units of mobile phones but doesn’t get the entire amount up front and they get paid for the half and the other half is a line of credit. In this example, one half of the amount is referred to as “account receivable” and will be recorded in the assets side of the balance sheet.

Account receivable is the term used to refer to the outstanding amount that is due to one by one’s debtor. It refers to the outstanding invoices and bills that a company has or even the money that the client owes the company. Oftentimes, only the term is replaced by a single word, “receivables”.

Basically, receivable is the amount of money that a company is liable to receive after having provided some products or services. Therefore, it is an asset to the company. It is listed in the balance sheet under the “Assets” column. It is basically a line of credit that the company has provided, along with their own services/products.

Account receivable – an integral part of the business

Almost every business today runs on a line of credit. This is because sometimes the company doesn’t have enough money, or sometimes just want so to get a line of credit for the moment. Most businesses offer this convenience only to those customers who are invoiced regularly, which means that they have good creditworthiness.

Account receivable is a testament of trust in business and has its own specialties when it comes to the way it is treated in accounting.

1. Terms involved in accounts receivables

Both parties involved agree upon a date and a period within which the payment has to be made. If payment is not made within that period, or even before the due date, the creditor can choose to turn over the accounts receivables balance to a collection agency or alternatively sue the company or person, thereby seeking compensation by the seizure of assets.

Some companies also use the concept of “reserves” in order to prepare for situations. The creditors are paid out of such reserves, in case of losses. A lot of companies offer early pay discount to their debtors, in order to clear their accounts receivable and increase cash flow.

2. Accounts receivable aging

All the accounts receivables of a company are summarized under accounts receivable aging report, which shows the invoices that are current, and also all the invoices that are overdue by a specific number of days, etc. This is the report that is used to estimate the appropriate size for an allowance for bad debts. The accounts receivables aging report is also a key tool in the hands of the collections department, which uses it to determine which of the invoices are overdue enough to follow up.

3. Some businesses don’t need to have accounts receivable

Some of the business conduct business when paid upfront. This leads to a redundancy of the accounts receivable. In such cases, the company is actually in liability because the amount is listed as “unearned revenue” or even “prepaid revenue”. The business process actually converts the unearned revenue into revenue through the manufacturing process (depending on the industry), which increases sales while reducing the liabilities.

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1 Comment

  1. Accounts receivable is a very valueable part of a finance function, collecting debt and avoiding bad bebts are key to success in business. A sale is not a sale until it is paid for as the old saying goes.

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