What is Account Receivable (AR)?
Account Receivable (AR) refers to the money owed to a company by its customers for goods or services delivered on credit. It represents a short-term asset on the balance sheet and reflects a business’s credit sales awaiting payment.
Definition
Account Receivable (AR) is the outstanding amount of money a company has the right to collect from customers who have purchased goods or services on credit terms.
Key Takeaways
- AR represents short-term assets that will be converted into cash through customer payments.
- Recorded as a current asset on the balance sheet.
- Indicates a company’s ability to manage credit and collect payments efficiently.
- Closely monitored through metrics such as Days Sales Outstanding (DSO) and Accounts Receivable Turnover Ratio.
- Integral to working capital and cash flow management.
Understanding Account Receivable (AR)
Accounts Receivable is created when a business sells goods or services on credit rather than requiring immediate cash payment. It is part of the company’s working capital cycle, bridging the time between delivery and customer payment.
For example, if a business delivers products worth $50,000 with payment due in 30 days, the transaction creates an Account Receivable entry. When the customer pays, the receivable is settled, and cash is recorded.
Efficient AR management ensures a steady cash flow and reduces the risk of bad debts. Companies often implement credit policies, perform credit checks, and use AR automation systems to streamline invoicing and collections.
Formula (If Applicable)
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
This ratio measures how many times a company collects its receivables during a period.
Days Sales Outstanding (DSO) = (Average Accounts Receivable / Total Credit Sales) × Number of Days
A lower DSO indicates faster collections and stronger liquidity.
Real-World Example
A manufacturing company sells $200,000 worth of machinery on net 45 terms. Until the client pays, this amount remains recorded as Accounts Receivable. Once payment is received, the AR account decreases, and cash increases by the same amount.
Large corporations like Apple and General Electric use automated AR systems integrated with ERP platforms to track invoices, send reminders, and manage customer credit risk.
Importance in Business or Economics
Accounts Receivable directly affects liquidity, profitability, and financial stability. It influences the company’s ability to fund operations, pay suppliers, and meet financial obligations.
In economic terms, AR balances contribute to the broader understanding of business credit cycles and corporate leverage. Managing AR efficiently helps maintain cash flow stability and reduces financing costs.
Types or Variations
- Trade Receivables: Amounts due from customers for product or service sales.
- Notes Receivable: Written promises (often with interest) to pay at a later date.
- Accrued Receivables: Income recognized but not yet billed.
- Factored Receivables: AR sold to a financial institution for immediate cash.
Related Terms
- Accounts Payable (AP)
- Working Capital
- Cash Conversion Cycle (CCC)
- Bad Debt Expense
- Credit Risk Management
Sources and Further Reading
- Investopedia – Accounts Receivable: https://www.investopedia.com/terms/a/accountsreceivable.asp
- Corporate Finance Institute (CFI) – AR Overview: https://corporatefinanceinstitute.com
- IFRS Standards – Asset Recognition: https://www.ifrs.org
Quick Reference
- Nature: Current asset.
- Purpose: Record customer credit sales.
- Key Metrics: DSO, AR Turnover Ratio.
- Management Tools: AR automation, invoicing systems.
- Impact: Directly affects liquidity and working capital.
Frequently Asked Questions (FAQs)
Is Accounts Receivable an asset or liability?
It’s an asset because it represents money owed to the business that will be received in the future.
How do AR and AP differ?
AR tracks what customers owe to the company, while AP tracks what the company owes to its suppliers.
What happens if customers don’t pay their AR?
Unpaid amounts are classified as bad debts and written off as an expense.
How can businesses improve AR collections?
By offering incentives for early payment, enforcing credit terms, and using automated billing systems.
