What it means
When a business sells on credit, it issues an invoice and waits for payment, commonly 30 to 60 days later. Until the cash arrives, the invoice amount sits in accounts receivable.
The sale counts as revenue straight away, even though the bank balance has not yet changed. This gap between profit and cash is why receivables matter so much.
A company can report strong sales and still run out of cash if customers pay slowly. Managers therefore track how long invoices stay unpaid and chase the overdue ones.
Not every receivable is collected. Some customers go bust, dispute invoices or simply never pay, so companies estimate the likely losses and set up an allowance for doubtful accounts (a reserve that reduces the receivables figure to what is realistically collectable).
Writing off a bad debt removes it from the books once collection is hopeless. Businesses use several tools to speed up collection, including clear payment terms, early payment discounts, automated reminders and credit checks on new customers.
Some also sell their invoices to a finance company, a practice called factoring, to receive cash immediately at a fee. Each choice involves a trade-off between cash now and the cost of getting it.
Accounts receivable is closely watched by lenders, who often lend against it. A growing balance can mean strong sales, but it can also signal weak collection or customers in trouble.
Looking at the balance alongside ageing data and sales growth gives a more honest picture. Concentration is another point to watch.
If a few customers make up most of the balance, one late payer can disrupt the whole cash plan, so businesses set credit limits and review large balances often. Spreading sales across many customers reduces this risk but takes more effort to manage.
In practice
Real-world examples
Example 1
A wholesale furniture business ships $85,000 of goods to a retailer on 45-day terms. The invoice goes into receivables immediately and the sale appears in the profit and loss account. The cash arrives six weeks later, so the business must fund its own costs in the meantime.
Example 2
A freelance web designer invoices a client $6,000 and then sends a polite reminder after 30 days. A small early payment discount of 2% persuades the client to pay in the first ten days. The designer prefers $5,880 now to $6,000 later, because the cash covers a bill that is due this week.
Example 3
A medical supplies firm discovers that two hospital customers account for 60% of its receivables. The CFO sets credit limits and monitors both balances weekly, since a late payment from either would strain the firm's cash and could delay its own supplier payments.
Think of it
Accounts Receivable is like lending your lawnmower to a neighbor who promises to pay you next week. You've provided something of value, and now you're waiting to collect what's owed.
Formula
Calculation
Ending accounts receivable = Opening accounts receivable + Credit sales - Cash collected - Write-offs
A training company starts the quarter with $200,000 owed by customers. It makes $600,000 of credit sales, collects $570,000 in cash and writes off a $10,000 invoice from a customer that has closed down. Ending accounts receivable = $200,000 + $600,000 - $570,000 - $10,000 = $220,000. The balance grew by $20,000, so the company has more cash tied up in unpaid invoices than it did three months ago.Case study
Seen in the real world
Silverline Signs is a fictional company making commercial signage that, in this illustrative story, reported a record profit of $400,000 but ran short of cash at the end of the year. The owner could not understand how a profitable business could be struggling to pay its staff.
The accountant showed that receivables had grown from $150,000 to $420,000 because the sales team had been offering 90-day terms to win large contracts. The profit was real, but $270,000 of it was still sitting in unpaid invoices.
The company shortened its standard terms to 45 days, asked for deposits on large orders and began chasing overdue invoices every week. Within two quarters receivables fell to $230,000 and the cash shortage eased, and the owner started reviewing the receivables balance at every monthly meeting.
Watch out
Common mistakes
- Treating a sale as cash in hand. Until the customer pays, the money is only a promise.
- Ignoring overdue invoices until they are very old. The longer a debt goes unpaid, the less likely it is to be collected.
- Letting the sales team set credit terms with no finance oversight. Generous terms win orders but can drain cash.
Questions
People also ask
Is accounts receivable an asset?
Yes, it is a current asset, because it represents money the business expects to collect within a year. If it cannot be collected, it must be written down.
What is a good collection period?
It depends on the industry and the terms offered. Collecting within the agreed terms, often 30 to 45 days, is a common goal.
What is the difference between accounts receivable and revenue?
Revenue is the sale itself, recorded when earned, whereas receivables are the unpaid portion still owed by customers. Revenue is on the profit and loss account and receivables on the balance sheet.
Watch