What Does Accounts Receivable Mean?
Accounts receivable is the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. Said another way, account receivable are amounts of money owed by customers to another entity for goods or services delivered or used on credit but not yet paid for by clients.
Accounts receivable refers to the outstanding invoices a company has or the money clients owe the company. The phrase refers to accounts a business has a right to receive because it has delivered a product or service. Accounts receivable, or receivables represent a line of credit extended by a company and normally have terms that require payments due within a relatively short time period, ranging from a few days to a fiscal or calendar year.
Understanding Accounts Receivable (AR)
Companies record accounts receivable as assets on their balance sheets since there is a legal obligation for the customer to pay the debt. Furthermore, accounts receivable are current assets, meaning the account balance is due from the debtor in one year or less. If a company has receivables, this means it has made a sale on credit but has yet to collect the money from the purchaser. Essentially, the company has accepted a short-term IOU from its client.
How Businesses Have Accounts Receivable
Most companies operate by allowing a portion of their sales to be on credit. Sometimes, businesses offer this credit to frequent or special customers receive periodic invoices. The practice allows customers to avoid the hassle of physically making payments as each transaction occurs. In other cases, businesses routinely offer all of their clients the ability to pay after receiving the service. For example, electric companies typically bill their clients after the clients received the electricity. While the electricity company waits for its customers to pay their bills, the company considers unpaid invoices a part of its accounts receivable.
Importance of Accounts Receivable
Accounts receivable is an important aspect of a businesses' fundamental analysis. Accounts receivables are current assets so they are a measure of a company's liquidity or ability to cover short-term obligations without additional cash flows. Fundamental analysts often evaluate accounts receivable in the context of turnover, which they call accounts receivable turnover ratio, which measures the number of times a company has collected on its accounts receivable balance during an accounting period. Further analysis would include days sales outstanding analysis, which measures the average collection period for a firm's receivables balance over a specified period.
Difference Between Accounts Receivables and Accounts Payable
When a company owes debts to its suppliers or other parties, these are accounts payable. Accounts payable are the opposite of accounts receivable. To illustrate, imagine Company A cleans Company B's carpets and sends a bill for the services. Company B owes the money, so it records the invoice in its accounts payable column. Company A is waiting to receive the money, so it records the bill in its accounts receivable column.