Accounts receivable or “AR” is a firm’s income that’s still on the horizon. Services have been provided or products have been sold on credit, so the buyer hasn’t yet paid for them. Customers may have made a down payment on the product or service, but the balance is still due and owing. In this case, the balance or remaining money owed represents accounts receivable.
AR is a current asset. It’s effectively part of a snapshot of a company’s liquidity and whether it will be able to pay its short-term debts without borrowing or accessing other sources of cash.
Definition and Examples of Accounts Receivable
Accounts receivable is an amount of money that’s owed to a company in the short-term for credit sales. Customers are receiving something now that they’ll pay for later.
For example, a credit card lender will front money to a consumer to make a purchase. The consumer doesn’t begin to pay that money back until the next billing cycle. The purchase amount is assigned to accounts receivable.
It would also fall under the umbrella of AR if a contractor repairs your hot water heater in an emergency and agrees to bill you for the service rather than demand payment upfront. You’re effectively purchasing that service on credit.
An accounts receivable turnover ratio analysis can define and account for how long the company expects these receivables to remain outstanding. And what if you don’t pay in either of these examples? The lender or contractor will move the money out of AR by writing it off as a doubtful account and/or tagging it as a bad debt expense. Accounts receivable is not guaranteed income, according to Accounting Education University.
How to Determine Accounts Receivable
- For bookkeeping purposes, AR typically begins with the first invoice issued to a customer for goods or services. The invoice or agreement should note credit terms and payment terms, including the date by which any outstanding balance should be paid.
- This information, including money paid, money owed and the payment due date, is then entered into a general ledger or into accounting software.
- The company will then track these accounts and pursue them for payment if they become past due and assign the money to outstanding balances.
- Receivables are recorded (debited) at the time services are rendered or products are sold, according to the Greater Washington Society of CPAs. They’re removed (credited) when customer payments are ultimately deposited into the firm’s account. Technically, the total of all such transactions that are entered into the sales ledger but not yet deleted represents the amount of a firm’s accounts receivable. That's where things can get tricky.
Where Can You Find Accounts Receivable on a Balance Sheet?
The accounts receivable balance is reported in the asset account section of a company’s balance sheet. This section tends to be broken down into categories, according to the Corporate Finance Institute. These can include current assets, property and equipment and goodwill. AR is a current asset, so it would appear in this subsection.
Technically, the total balance from the ledger that’s entered onto the balance sheet should be reported minus an overall allowance for accounts that won’t ultimately be paid, according to the CFA Institute. These accounts and unpaid invoices may be turned over to a collection agency. This is the “bad debt” factor.
Accounts Payable vs. Accounts Receivable
Accounts payable or “AP” is the opposite of accounts receivable. It's money and debts that the business owes.
Let’s assume that your small business – not you personally – experiences a hot water heater meltdown. The contractor allows your company to pay the bill over time. Your business would enter this on its books as accounts payable. AP totals are entered into the liabilities section of the balance sheet.
Cash Flow vs. Accounts Receivable
Accounts payable are converted to cash or working capital as customers pay their balances, either gradually over time or all at once. Payments made over time are subtracted (credited) and converted from AR incrementally.
Both are critical to the success of your small business. You’ll need cash or cash equivalents to purchase inventory, supplies and the like and to meet payroll if you have employees without the necessity of borrowing. Therefore, AR is representative of the overall sales that will keep you in business.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.