Understanding Accounts Receivable: What It Means and Why It Matters


The balance of money owed by a company for goods or services delivered or used but not yet paid by clients is referred to as accounts receivable. These are goods and services provided by a company on credit to its client with the knowledge that payment will occur later.

Accounts receivable are the remaining invoices owed by the customer to the company or money. The term refers to accounts received by a company for goods and services.

Receivables represent an extended line of credit from a company to the client that requires payments due in a relatively short period, ranging from a few days to a fiscal year.

Most companies allow for a portion of their sales to be on credit. Often, a business offers this credit to frequent or special customers who receive periodic invoices. This allows customers to avoid having to make payments as each transaction occurs. Other businesses routinely offer all their clients the ability to pay after receiving the service. An electricity company is an example of a company with accounts receivable. They provide electricity to space and wait for payment from their customers. Unpaid invoices are a part of accounts receivable.

In this article we will we also discuss:

What Kind of Account Is Accounts Receivable?

Good accounting requires that an estimate be made for any amount in Accounts Receivable that is unlikely to be collected. The estimated amount is reported as a credit balance in a contra-receivable account such as Allowance for Doubtful Accounts. This credit balance will cause the number of accounts receivable reported on the balance sheet to be reduced. Any adjustment to the Allowance account will also affect Uncollectible Accounts Expense, reported on the income statement.

Example of Accounts Receivable

An example of accounts receivable includes an electric company that bills its clients after receiving the electricity. The electric company records an account receivable for unpaid invoices as it waits for its customers to pay their bills. 

Most companies operate by allowing a portion of their sales to be on credit. Sometimes, businesses offer this credit to frequent or special customers that receive periodic invoices. The practice allows customers to avoid the hassle of physically making payments as each transaction occurs. In other cases, businesses routinely offer all of their clients the ability to pay after receiving the service.

Benefits of accounts receivable

Tracking your accounts receivable is crucial to managing your cash flow. While your sales might be going well, if your accounts receivable continues to grow and your customers aren’t paying you fast enough, you could find yourself in a cash crunch.

This is a classic example of why fast growth can be challenging for small companies. While you’re making sales and delivering your product, if you aren’t getting paid fast enough, you may have trouble fulfilling orders in the future or even paying basic business expenses because you don’t have the cash in the bank.

Tracking accounts receivable is critical to staying on top of the situation to make sure to collect the money that is owed to you.

You should track not only the total accounts receivable number (how much all of your customers combined owe you) but who owes you and which customers are behind on their payments. With this knowledge, you can decide which customers to chase down for payment and keep your bank account full.

What Is the Journal Entry for Accounts Receivable?

With accrual accounting, you record a transaction whether cash has been received or not. This the system in which you record an account receivable. When a sale of services is made to a customer, you use your accounting software to create an invoice that automatically creates an entry to credit the sales account and debit the accounts receivable account.

After the customer pays the invoice, the cash account would be debited, and the accounts receivable account would be credited.

Accounts receivable vs. accounts payable

While accounts receivable is money owed to you, accounts payable (AP) represents money that you owe to suppliers. Considered to be short-term debt, you need to be able to find a balance between both of these outstanding accounts.

Typically, you’re looking to extend the due date of your own bills while shortening the time it takes for your customers to pay you. This ensures you have enough cash available to cover your accounts payable and won’t encounter any cash problems. If you’re struggling to find this balance the best way to improve your immediate cash position is to find ways to decrease your outstanding accounts receivable.

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