What are Receivables
Receivables, also referred to as accounts receivable, are debts owed to a company by its customers for goods or services that have been delivered or used but not yet paid for.
BREAKING DOWN Receivables
Receivables are created by extending a line of credit to customers and are reported as current assets on a company's balance sheet. They are considered a liquid asset, because they can be used as collateral to secure a loan to help meet short-term obligations.
Receivables are part of a company’s working capital. Managing receivables, and immediately following up with any customer who has not paid is important, because it provides extra capital to support operations, and lowers the company’s net debt. To improve cashflow a company can reduce credit terms or take longer to pay its accounts payable – which is known as shortening the cash conversion cycle. It can also sell receivables at a discount to a factor, which takes over responsibility for collecting money owed and reducing non-payment.
To measure how effectively a company extends credit and collects debt on that credit, fundamental analysts look at its receivables turnover ratio. This is the net value of credit sales during a given period divided by the average accounts receivable during the same period. Average accounts receivable can be calculated by adding the value of accounts receivable at the beginning of the desired period to their value at the end of the period and dividing the sum by two. Another measure of a company’s ability to collect receivables is days sales outstanding (DSO), the average number of days that it takes to collect payment after a sale has been made.
Allowance for Doubtful Accounts
Because expenses must be recognized in the same accounting period that the revenue is earned, rather than when payment is made, under generally accepted accounting principles (GAAP), companies estimate a dollar amount for uncollectible accounts using the allowance method. This estimate for bad debt losses is an expensed cost on the income statement and recorded in a contra account within accounts receivable on the balance sheet called the allowance for doubtful accounts — which reduces the accounts receivable.
Any increase to allowance for credit losses is also recorded in the income statement as a bad debt expense. Recognizing bad debts leads to an offsetting reduction to accounts receivable on the balance sheet – though businesses retain the right to collect funds should the circumstances change. This allowance can accumulate across accounting periods and may be adjusted based on the balance in the account.
If a company sells widgets and sells 30% of them on credit, it means 30% of the company's receipts are receivables. That is, the cash has not been received but is still recorded on the books as revenue. Instead of an increase in cash, the company credits accounts receivable. They are both considered an asset, but a receivable is not considered cash until it is paid. If the customer pays the bill in six months, on the seventh month the receivable is turned into cash and the same amount of cash received is deducted from receivables.