What is Accounts Receivable
Accounts receivable refers to all the payments a service provider expects from a third-party company concerning goods or services provided to the company on credit. This type of account is mostly logged into the primary ledger of the company, and it is a claim, which is legally binding on the creditor. Third-party companies that usually receive goods or services on credit through accounts receivable include hospitals, banks, corporations, and individuals. Proper management of accounts receivable requires good recordkeeping on balance sheets in the form of current assets. In most cases, the credit period of accounts receivable ranges from days to a couple of months. The credit period could be up to a year in some instances.
Accounts receivable is the opposite of the accounts payable. The main difference between accounts receivable and accounts payable is that for the former, money is owed, while for the latter, money is received.
Importance
Running and maintaining reliable accounts receivable is essential for the operations of a company that provides goods or services on credit to businesses or individuals. The following are some points that highlight the importance of the management of accounts receivable.
- Any company that has accounts receivable means that it expects revenue from sales of goods or services. It’s a good step towards creating lasting relationships with reliable partners. It is also helpful in attracting new clients.
- It is also useful in measuring the company’s capacity to deliver on its commitments without receiving payments within a short timeframe.
- Accounts receivable is used by service providers to provide goods or services on credit to companies that may not necessarily have the ability to pay upfront. This is helpful to third-party companies as they can access goods or services as required and pay later.
- It serves as a reliable source of revenue as many companies prefer getting services or goods now and paying later.
Usage
Accounts receivable is useful for managing and encouraging the flow of cash into the company from businesses or individuals through the provision of goods or services on credit. Other important uses include the following.
- Companies that have accounts receivable can use it to obtain asset-based loans from financial institutions. A company may also opt to sell it in the exchange or capital market to generate funds.
- It can be used to measure a company’s customer relationships with its clients. High accounts receivable may indicate that the company may be too relaxed concerning debit recovery, which can serve as a sign for a possible cash crunch. Low accounts receivable may indicate that the company is too strict with debt recovery, which can translate to hostile customer relations. Other essential financial indicators, such as current ratio, days payable, and working capital, are affected by the status of the accounts receivable of a company.
Example
Consider a Company A as a restaurant that provides catering services to Company B during workshops that usually last for five days. Company A supplies food worth $3,000 for a workshop with the agreement that the money would be paid in precisely 30 days by Company B. At this moment, Company A decreases the total amount of its main account by $3,000 while increasing the accounts receivable by $3,000. After 30 days, Company A receives the payment of $3,000, which increases its income by $3,000 while reducing the accounts receivable by a similar amount.
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