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Accounts Receivable
What Are Accounts Receivable?
Accounts receivable refer to sales for which payment has not yet been received. The business extends credit, expecting future payment. For the customer, this transaction is recorded as an account payable. These entries should offset each other, balancing the transaction.
For instance, if Business A sells a $100 product, it records this as an account receivable. Conversely, Business B records it as an account payable. Once payment is made, both accounts are settled: Business A receives $100, and Business B clears its debt.
Accounts receivable are crucial as they represent assets that can be converted to cash, indicating the business's ability to turn sales into revenue. Typically collected within two months, they are considered a "short-term asset." Extending credit builds customer trust and expands the customer base but also carries the risk of bad debt.
How Are Accounts Receivable Recorded?
Recording accounts receivable begins with issuing an invoice, which details the transaction, including:
- Provider and recipient names
- Description of goods or services
- Date of provision
- Quantity or amount
- Value exchanged
- Payment terms
Once invoiced, the transaction is tracked to ensure payment. It is recorded in the business’s accounting books, typically in a subsidiary ledger (subledger) of the general ledger. Transactions in the subledger are summarized in a control account to prevent clutter in the general ledger.As a journal entry, accounts receivable are recorded as an asset (debit) and revenue (credit). When payment is received, it is credited to accounts receivable and debited to cash, zeroing out the accounts receivable and reflecting cash revenue.
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Are There Metrics for Accounts Receivable?
Accounts receivable metrics are essential for assessing business performance:
- Receivables-to-Sales Ratio: This metric compares accounts receivable to sales over a specific period. A high ratio indicates more sales are on credit rather than cash, suggesting increased risk in the customer base, which is unfavorable.
- Receivables Turnover Ratio: The inverse of the receivables-to-sales ratio, it measures how effectively a business collects its receivables. A higher ratio indicates successful collection efforts, which is beneficial for the business.
- Days Sales Outstanding (DSO): Calculated by dividing average accounts receivable by sales and multiplying by 365, this metric shows the average time taken to convert receivables into cash.
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