Accounts receivable (often abbreviated as AR or A/R) refers to the money owed to a business by its customers for goods or services that have been delivered or provided on credit but not yet paid for. It’s essentially a short-term debt owed to your company by an external party, and it’s considered a current asset on your balance sheet because you expect to collect it within a relatively short period, usually within one year.
Think of it as the inverse of a credit card bill from the perspective of the merchant. When a company sells something and allows the customer to pay later (e.g., net 30 days, net 60 days), that deferred payment becomes an account receivable.
Why Accounts Receivable Are Important
Accounts receivable are crucial for a business’s financial health and operations because they:
- Represent Future Cash Flow: While not actual cash yet, AR signifies money that the company is legally owed and expects to receive, which will eventually convert into cash available for expenses, investments, or other uses.
- Indicate Revenue Earned: Under accrual basis accounting (the most common method), revenue is recognized when it’s earned (i.e., when the goods are delivered or services performed), regardless of when the cash is received. AR reflects this earned but uncollected revenue.
- Assess Financial Health: The amount and age of a company’s accounts receivable provide insights into its liquidity, credit policies, and effectiveness of its collections process. High or rapidly increasing AR could indicate strong sales, but also potential collection issues if not managed well.
- Facilitate Credit Sales: Offering credit terms to customers is a common business practice that encourages sales, builds customer relationships, and can be a competitive advantage. AR is the result of these credit sales.
How Accounts Receivable Works in Practice
- Sale on Credit: A business provides a product or service to a customer.
- Invoice Issued: The business then sends an invoice to the customer, detailing the amount owed, the goods/services provided, and the payment terms (e.g., “Net 30,” meaning payment is due in 30 days).
- AR Recorded: Upon issuing the invoice, the business records the amount as an account receivable in its accounting system. This increases its assets.
- Tracking and Collection: The accounts receivable department (or the person responsible for it) tracks outstanding invoices, sends reminders, and follows up on overdue payments. This often involves creating an “aging report” that categorizes receivables by how long they’ve been outstanding (e.g., 0-30 days, 31-60 days, over 90 days).
- Payment Received: Once the customer pays the invoice, the accounts receivable balance is reduced, and the cash account is increased.
Accounts Receivable vs. Accounts Payable
Accounts receivable is the opposite side of the coin to accounts payable.
- Accounts Receivable (AR): Money owed to your business by others (an asset).
- Accounts Payable (AP): Money your business owes to others (a liability).
When one company records an account receivable, the other company (the buyer) records an account payable.
Other Receivables (including Employee Receivables)
While “accounts receivable” specifically refers to money owed by customers for goods/services, other types of “receivables” can exist on a company’s balance sheet. For instance, employee receivable refers to amounts owed to the company by its own employees. This could include things like:
- Employee loans
- Salary advances
- Unreimbursed personal expenses charged to a company card
- Overpayments in payroll that need to be recovered
- Costs for damaged or unreturned company property
- Travel advances not fully accounted for
These specific types of receivables are typically tracked in separate accounts within the general ledger, distinct from customer accounts receivable, because their nature and collection process differ.