What Is Accounts Receivable and How Does It Work?
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Accounts receivable, often abbreviated to AR or A/R, refers to the amount of money customers or other companies owe to a business. Businesses only use accounts receivable for purchases made on credit, so it supplies the goods or services before customers pay for them. Understanding accounts receivable and its process can help you understand accounting processes for a business. In this article, we will take an in-depth look at what accounts receivable means, explore the businesses that use AR and answer some frequently asked questions.
What is accounts receivable?
In accounting, “receivables” means a company has provided goods or services but has not yet received the proceeds. Receivables are considered to be assets, even though the business has not yet received the money. At larger companies, there may be a whole department dedicated to accounts receivable. It is common for businesses to allow customers to receive goods or services before paying for them.
For example, a lawyer at a firm may provide services to a client, and after the job is complete, they will send an invoice to that client. The lawyer files this invoice under accounts receivable. It will stay that way until the client pays for legal services. Usually, these payments are due within a year or less of the completed work date.
Key accounts receivable points
Here are a few key accounts receivable points:
Accounts receivable means money owed to a business for a service they provided
Many different types of businesses use AR
AR accounts are an asset to that company, even though the company has yet to receive the funds
Invoices are AR until they're fully paid
Working in the field of accounts receivable can be a full-time job
How does an accounts receivable process work?
The accounts receivable process enables a business to track its incoming funds. Here are the steps of the accounts receivable process:
1. Developing credit practices
Accounts receivable is an opportunity for customers to purchase goods or services on credit. If a customer has a bad credit history when it comes to payment, then your business may choose not to work with them. It is up to the business to analyse the past payment patterns of that client.
Once the business decides to do the job for a client, the business creates a document. This will include the terms and conditions of the sale. The business should include full disclosures for credit practices. A lawyer will determine if the document abides by federal laws. The terms and conditions will vary based on the business itself. Larger companies can allow longer credit periods. A small company may have limited cash flow so the payment date will be shorter.
The business then creates an invoice. An invoice outlines exactly what the customer has purchased and the price of each item. It also states a due date, a unique number for retrieval purposes and any GST owed. Invoices can either be physical or paperless (online invoices). Companies can send invoices as soon as the customers enter a purchase agreement with the business. This ensures a company can receive prompt payment.
Tracking your accounts receivable is crucial to good business practice. The role of tracking these payments usually falls to the AR officer if a company has one. Or to the person who does the accounting, common for smaller companies. The AR officer tracks the purchase and generates the invoice. The officer can then track the invoice and update it in the ledger when the customer or vendor pays the money. Some companies will have automated processes for tracking.
4. Accounts receivable accounting
The accountant or collections officer will determine the due dates for each invoice. The AR officer can then identify any unpaid invoices. Part of the AR officers' job is to carry out account reconciliations. This includes accounting for unpaid debts, bad debts and early payment customers.
Job description guide for accounts receivable officers
Working as an accounts receivable officer means you are responsible for ensuring a business receives payments. Another party, like a customer or another business, owes the money in exchange for goods and services. You will can record all the information accordingly and keep track of all the accounts receivable. You can have excellent attention to detail and organisational skills. A typical job description of an accounts receivable officer may look like this:
Maintaining accounts and billing
Generating invoices and statements
Maintaining the accounts receivable records
Producing financial reports on a monthly basis
Resolving account irregularities
Carry out account reconciliations
Assisting in other financial matters
Any accounts receivable role requires accounting experience. The successful candidate may have a degree in accounting, finance, economics, commerce or mathematics. Some skills required for applicants are:
Ability to manage expectations
Ability to work independently
How businesses use accounts receivable
Businesses can use the accounts receivable method in a few different ways. Firstly, it is used for clients who purchase goods or services on credit. That means they receive the goods or services before paying for them. It is a common way for many companies to provide services. These companies can include:
Many small businesses
Another way companies use the AR method is when a business decides to let a customer pay for a service over an extended period of time. This is slightly risky, so the business should only offer it to trusted clients. The upside to this method is that the client will have to pay slightly more over time because of accrued interest. These sorts of deals are attractive to consumers because it allows them to purchase an expensive item and slowly pay it off. Businesses like these deals because it means they can close a sale before they receive full payment.
The final way a business may use AR is with regular clients. These sorts of deals are common in restaurants where they have regular food deliveries. For example, a local farmer provides vegetables to a restaurant every week. First, the restaurant and the farmer can establish a relationship. The farmer then decides to set up a provisional agreement. This means the restaurant will pay the farmer regularly over a chosen time period e.g. monthly. While the farmer continues to deliver the goods weekly. The restaurant would be part of the farmer's accounts receivable.
Frequently asked questions
Below we answer some of the most commonly asked questions about accounts receivable:
What is the difference between accounts receivable and accounts payable?
Accounts payable is the opposite of accounts receivable. If your company owes another money for a service, then this goes under accounts payable. Payable accounts are considered to be liabilities. This is because it is money owed to another company.
For example, a building company does some renovating work for a florist. The building company will then invoice the florist, which goes under accounts receivable for the building company. The florist files this invoice under accounts payable. Once the florist has paid the money and the building company has received it accordingly, the transaction is complete.
What are the benefits of accounts receivable?
When analysing a business, the accounts receivable is an important factor for valuation. Accounts receivable are classed as assets, therefore it shows a company's liquidity. Liquidity refers to a company's ability to use its current assets to cover any short-term liabilities. Accounts receivable allows businesses to increase control over cash and working capital as well as increase customer loyalty.
What is accounts receivable in simple words?
Simply put, accounts receivable means the amount of money a business's customers owe. The invoice stays marked AR until the business receives the money in full. Accounts receivable is a way of tracking the money owed to your business. Many industries use accounts receivable, including utility companies, small businesses, law firms and more.
Are accounts receivable debit or credit?
In the world of accounting, debit means assets, and credit means liabilities. Businesses class accounts receivable as debit. Even though the company hasn't physically received the money yet, AR indicates the payment will come shortly. It is, therefore, counted as an asset.
What happens if a customer never pays their invoice?
After several failed attempts at trying to collect a debt from a customer, a business may eventually deem the debt uneconomical to pursue further. In this case, the business will usually then write off the expense as a bad debt expense.
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