Accounts Receivable

Accounts Receivable And Cash Flow

What is AR?

Accounts Receivable (AR), also referred to as just receivables, result from sales transactions. These are the amounts owed or short term debts to a company by its customers and clients for services or goods provided.

In most business entities some portion of the sales are allowed to be conducted on credit. Such sales are made to old, loyal, frequent or special customers so that they can avoid the trouble of making payment for each transaction. An invoice is generated and mailed to the customer who must pay within the specified time period called credit or payment terms.

Depending upon industry standards and a company's own corporate policy, payments can be received up to 10-15 days beyond the established time frame.  

On the balance sheet of a company, receivables are recorded as current asset, because customers are legally bound to pay the amount in a short period ranging from a few days to a year.

While recording a sale on account, the journal entry debits a receivable and credits a revenue account. Once the payment is made, cash is debited and receivable credited in the journal entry. On the trial balance sheet, the ending balance for accounts receivable is always debit. Most companies use accounting software especially designed for these purposes to maintain these accounts. 

Influence On Cash Flow

Receivables are a means of cash inflow and, if not duly realized, may seriously obstruct cash outflow obligations. That is, if a company conducts a lot of business on credit, bad debts and slow paying customers may leave the company with cash shortage, not even enough to meet its own needs. That is, it may not have enough positive working capital. For this purpose most companies have a credit control department that constantly monitors and regulates all aspects of sales made on credit.

So, while in theory receivables may appear to be a simple accounts transaction, the follow up and realization of these debts is vital and involves tremendous hard work. Often it is outsourced to dedicated companies called recovery or collection agencies.

Businesses usually allow a bad debt margin, since not all payments are always made. This allowance is subtracted from total receivables when measuring its net value. This is an important evaluation because companies can use their receivables as collateral to obtain a loan. This process is called invoice discounting. Also receivables can be sold through a process called factoring whereby the purchaser, usually a bank, evaluates the receivables and buys them at a price lower than the net worth. Accounts receivable are a very important asset because their salability and value as collateral depends upon the creditworthiness of the customers. So when trying to obtain a loan, even a company with a poor credit history but with good customers stands a better chance.