Accounts Receivable (AR)

Accounts receivable (AR) definition

The total amount of money owed to a business for delivered or consumed but unpaid goods or services is known as accounts receivable (AR). Any money due by a client for purchases bought on credit is referred to as AR, and all outstanding invoices are represented as current assets on the balance sheet.

A company's balance sheet includes an accounts receivable column that contains all of the existing debts, including bills, loans, and open unpaid invoices. It comprises both short-term and long-term receivables, with short-term debts being those incurred within 12 months and long-term obligations being those incurred for longer than a year.

Benefits of accounts receivable

An essential component of a company's financial statements is its accounts receivable. They gauge a business's liquidity, or its capacity to pay short-term debts without needing additional cash flow.

The accounts receivable turnover ratio, often known as turnover, is the typical metric used by fundamental analysts to assess accounts receivable. The turnover ratio calculates how frequently a business has collected its account receivable balance throughout an accounting period.

Assessing days sold outstanding (DSO), which gauges the typical time it takes to collect cash payment after a sale, would be a step further in the analytical process.

Accounts receivable: Where are they recorded?

Accounts receivable are found on the balance sheet of a firm. They represent funds owed to a company and are recorded as an asset.

Because they represent cash collected from customers, they are typically classified as current assets. However, because most accounts receivable are expected to be paid out over time, many firms classify them as long-term assets. This is especially true of those that sell products on credit terms.

Accounts receivable and accounts payable: What do they have in common?

Accounts payable and accounts receivable are closely related terms that describe how money flows through a business. Each of those accounts represents a different type of transaction that needs to happen within a company.

The difference between accounts payable and accounts receivable is pretty straightforward. An accounts payable balance indicates what a company owes others; it is essentially a list of customer invoices. Whereas an accounts receivable balance reflects what a company owes itself; it is basically a list of unpaid bills.

Both accounts represent transactions that occur between a company and someone else, and each of these transactions requires a specific set of steps to complete successfully. A company must receive payments from customers, collect outstanding balances due, and ensure that incoming payments are applied correctly. These processes are reflected in the accounts payable and accounts receivable balances.

In addition to being important indicators of a company's cash flow, these accounts provide information about a company's overall financial health. They are used to calculate key ratios such as days sales outstanding, inventory turnover, working capital, and profitability.