Accounts Receivable (A/R) is an accounting term used to refer to the money that is owed to a company by its customers. The customers, who may be individuals or corporations, are the debtors, since they owe money for the goods or services provided by the company on credit.
Accounts receivable is considered to be an important factor in a company’s working capital and is reported as a current asset on the balance sheet.
For example, Tough Tyres Limited receives an order for tyres worth $1 million from Zoom Auto Limited. The order is accepted and the tyres are supplied with an invoice to Zoom Auto Limited. The supply has been made on credit and the customer is given a 90-day period to pay for the tyre purchase. Based on these transactions, Tough Tyres' inventory account decreases by $1 million and its accounts receivable increases by $1 million. When 90 days have passed and the payments are made, the accounts receivable goes down by $1 million while the cash with the company rises by $1 million.
When a product is sold on credit, the company sets a term for its accounts receivable. The term is the number of days given to a customer to honor the commitment of paying the bill amount. If the bill is not paid, then the customer may be charged a late fee or turned over to a collection agency. Most terms are set for 30, 60 or 90 days.
In general, if the amount of accounts receivable is too high, this reflects delays and laxity in the collection process and the company may find it hard to pay its current obligations. On the other hand, if the levels are too low, this indicates the company’s rigidity in its payment terms, as it may not be offering enough leeway to its customers.
Accounts receivable is considered good for a business as it is seen as turning into cash within a certain time frame. But if not handled properly (money due is not recovered) then the company may even be forced to write off its receivables on the balance sheet.
The process of supplying good and services on credit should be based on the reliability of clients and companies should follow up to ensure timely payments.