Accounts Receivable

Table of Contents

What is AR aka Accounts Receivable?

What are some examples of Accounts Receivable?

What is Accounts Receivable Important?

What is AR aka Accounts Receivable?

Accounts Receivable is money owed to a company by customers for goods and services they have not yet paid for. Accounts receivable are recorded as a current asset on the balance sheet because they are expected to received as cash within a year.

Accounts receivable is more likely to be relevant to companies making larger sales in the thousands and millions of dollars. Large purchases in both B2B and B2C businesses are often not paid for in full at the time of purchase, for example a real estate developer may purchase millions in building materials, take delivery of them immediately, and then pay their suppliers over time. Accounts receivable is used by the suppliers to account for how much money is still owed by the developer (and the developer record the same amount as a current liability called Accounts Payable).

What are some examples of Accounts Receivable?

Accounts receivable is a very common item on the balance sheet across industries. Here are a few examples:

  1. Business Consultancy: a business consultancy may sell a year contract to a client for their services, which is to be paid on a quarterly basis. The Consultancy would record the sale of a year contract and the proceeds as accounts receivable, which would be reduced as cash payment is made by the client each quarter
  2. B2B SaaS: a B2B SaaS company may sell yearly contracts at a discount to a monthly price but are paid on monthly basis. This company would record the unpaid monthly installments that are covered under the annual contract as accounts receivable
  3. eCommerce Apparel: a eCommerce store may sell their merchandise wholesale to a set of brick & mortar and digital resellers, and their arrangement with the secondary sellers could be that they get paid half when upon purchase and half upon receipt and inspection of the inventory. The unpaid portion would be recorded as accounts receivable until the inventory is delivered and approved

Why is Accounts Receivable Important?

The most important reason for Accounts receivable to record how much money is owed to a business by its customers. However, it's common sense that it's important to a business not just that it gets paid the money it is owed, but also how quickly it is able to get paid. It's important to remember that while it's recorded as an asset, Accounts receivable is not cash in hand - it is money owed, and sometimes it can take longer than expected to get paid back, or not get paid back at all.

There are a couple of metrics that are used to measure a company's speed and success in collecting on their accounts receivable:

  • Day Sales Outstanding (DSO): a measure of the average number of days that it takes a company to collect payment for a sale
  • Receivables Turnover Ratio: an measure used to quantify a company's effectiveness in collecting its accounts receivable

Going into the details of these metrics is beyond the scope of this entry, the key takeaway is that the speed and success of collecting on accounts receivable can have a big effect on the health of a business.