Accounts receivable refers to sales the business has made but for which payment has not yet been received.
The customer has not paid for the good or service received at the time of the transaction. Instead, the business has extended credit to the customer and expects to receive payment for the transaction at some point in the future.
Reporting of these transactions reflects the unique nature of accounts receivable and the particular metrics that they provide.
The first step in recording accounts receivable is the invoice. The invoice is a document produced by the business to record the details of a transaction. The information contained in the invoice is vital to both the business and the customer. It will contain all of the vital information related to the transaction, including:
The name of the entity or unit providing the good or service
The recipient of the good or service
The good or service provided
The date on which it was provided
The quantity or amount that was provided
The value of the resource that was exchanged
As it relates to accounts receivable, an invoice will also contain important details about the terms of payment for the transaction.
Once the invoice has been generated, the business should track it to determine if the customer has fulfilled the obligation for payment.
Based on the invoice, the transaction will be entered into the business’s accounting books.
Typically, accounts receivable transactions will be entered into a subsidiary ledger of the general ledger.
All transactions in the subsidiary ledger will be aggregated into what is called a control account. A control account is a summary-level account within the general ledger that contains aggregated totals for individual transactions stored in subsidiary level ledgers and is designed to avoid cluttering the general ledger with too much detail.
As a journal entry, individual transactions representing accounts receivable will be recorded as an asset on the debit side of the ledger and as revenue on the credit side. They are recorded as an asset because they represent revenue for the company that can be collected or converted to cash in the near future. They are recorded as revenue because they represent the proceeds from a transaction that is owed to the business.
When payment is received, the transaction will be recorded as a credit to the account receivable asset and as a debit to the cash account. The accounts receivable account will cancel out to zero, and the transaction will appear as revenue in the form of cash.
Accounts receivable are considered a “short-term asset” which is any financial resource that can be converted to cash in one year or less, because they are typically collected in two months or less.
Most businesses have accounts receivable in their accounting ledger. While in a perfect world all accounts receivable will be collected in the standard amount of time, in reality this is not always the case.
Accounts receivable collections is the process a business undergoes to ensure that customers follow through on payments for services or products provided. Before initiating collections, the business must make an evaluation of its accounts receivable.
To aid in this evaluation, the business will produce an aging report.
An aging report will provide the business with a snapshot of the status of all its accounts receivable by categorizing them according to how long they are past due.
The aging report organizes individual accounts receivable into groups depending on how much they are past due. The typical groupings are:
0-30 days
31-60 days
61-90 days
More than 90 days
The status of each group reflects the time that has elapsed since an invoice was issued to the customer. The aging report will help the business organize and evaluate the status of its accounts receivable.
The aging report is also used as a tool for estimating potential bad debts, which are then used to revise what is known as the allowance for doubtful accounts.
To remain consistent with the matching principal, businesses will write-off bad debt by setting aside a reserve for expected bad debts or so-called doubtful accounts. This reserve, or allowance, is also referred to as a contra asset account because it nets or balances against the accounts receivable assets listed in the balance sheet.
The aging report helps the business calculate these estimates by providing a standard amount of time its accounts receivable go uncollected and how many are charged off.
Accounts receivable are an important accounting metric. They represent convertible assets owed by the company. That is, they describe a financial resource that can be converted to cash in the near future, once the customer has paid.
Similarly, they are the basis for measuring the business’s ability to convert sales into cash. When payments are not collected for accounts receivable this is an indicator that the business is not performing. Accounts receivable are used to measure the performance of the business in a number of ways. The receivables-to-sales ratio measures the accounts receivable in proportion to its sales for a given period of time.
A high number shows that a greater number of sales are generating accounts receivable, as opposed to cash. This reveals a higher level of risk in the customer base and is not a good sign for the business.
The receivables turnover ratio is the inverse of the receivables-to-sales ratio. It measures sales as a proportion of accounts receivable.
In contrast, a higher number reveals a better success rate in collecting payment accounts receivable, which is a positive sign for the business. Lastly, the days-sales-outstanding is calculated as the average number of accounts receivables divided by sales then multiplied by 365. This ratio shows how long it takes a company to convert its receivables into cash.
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