Receivable

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Accounts Receivable (AR): Definition and Key Points

Accounts receivable (AR) is the amount of money a business is owed for goods or services it has delivered but not yet been paid for. It appears on the balance sheet as a current asset because payment is expected within one year and it contributes to a company’s working capital and liquidity.

How AR Works

  • AR arises when a company extends credit to customers—customers receive the product or service now and pay later under agreed terms (e.g., 30, 60, 90 days).
  • Because customers have a legal obligation to pay, AR is recorded as an asset and can sometimes be used as collateral for short-term financing.
  • If payment terms include interest, the receivable may accrue interest after a set period.

Receivable vs. Payable

  • Accounts receivable: funds owed to the company (asset).
  • Accounts payable: funds the company owes others (liability).
    Example: If Company A provides a service to Company B and invoices them, Company A records an account receivable while Company B records an account payable.

What AR Reveals About a Business

  • Liquidity: AR contributes to a company’s ability to meet short-term obligations.
  • Credit policy and collection effectiveness: large or growing AR balances can indicate generous credit terms or collection problems.
  • Customer credit quality: high levels of overdue receivables may signal risky customers or weak credit controls.

Key Metrics

  • Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable.
  • Measures how many times receivables are collected in a period; higher is generally better.
  • Days Sales Outstanding (DSO) = (Average Accounts Receivable / Net Credit Sales) × Number of Days.
  • Indicates the average number of days it takes to collect a receivable; lower DSO is preferable.

Examples

  • Utility companies bill customers after consumption; unpaid bills are recorded as accounts receivable until collected.
  • A manufacturer shipping goods on 60-day terms records AR until the buyer pays.

Uncollectible Receivables

  • When collection is deemed unlikely, the receivable is written off as a bad debt expense or charged against an allowance for doubtful accounts.
  • Companies may sell delinquent receivables to third-party collectors at a discount; this is often called discounted receivables.

Net Receivables

Net receivables = Total accounts receivable − Allowance for doubtful accounts.
This figure reflects the amount the company realistically expects to collect.

Practical Takeaways

  • Shorter collection periods and strong turnover ratios improve cash flow and financial flexibility.
  • Rising AR without corresponding revenue growth can indicate weak collections or deteriorating customer credit.
  • Monitoring AR trends and related metrics is essential for managing working capital and assessing financial health.

Bottom Line

Accounts receivable represent promised future cash inflows from customers and are a core component of a company’s current assets. Proper management—through credit policies, monitoring turnover and DSO, and timely write-offs—helps maintain liquidity and reduces the risk of unexpected losses.