Accounts receivable (AR) is the money customers owe a business for goods or services it has already delivered on credit, that is, sold with an invoice to be paid later rather than for cash on the spot. The term covers both the asset shown on the balance sheet and the process of granting credit, invoicing, collecting and recording customer payments.
Accounts receivable is the counterpart of accounts payable: each invoice is a receivable for the seller and a payable for the buyer. Trade receivables are normally current assets and a major part of working capital. Under accrual accounting, revenue is recognised when it is earned under the rules for revenue recognition, even if the cash arrives later; the receivable bridges that gap.
Accounts receivable in plain terms
Think of a plumber who fixes a boiler for an office and leaves an invoice payable in 30 days. The job is done and the plumber has earned the money, but it is not yet in the bank. The list of everyone who owes the plumber money, and how long each has owed it, is the plumber's accounts receivable.
Some customers pay on time, some need reminders and a few never pay. Managing receivables means deciding whom to trust with credit, sending clear invoices, chasing late payers politely but firmly, and admitting when a debt will not be collected.
How the AR process works
The order-to-cash cycle usually follows these steps:
- Credit decision. The seller checks a new customer's standing, often using trade references or reports from a credit bureau, and sets a credit limit and payment terms.
- Invoicing. After delivery, an invoice is issued with amount, due date, payment instructions and references the customer will quote.
- Collection. Reminders go out before and after the due date; overdue accounts are escalated, put on hold or passed to a collection agency.
- Cash application. When payment arrives, cash application matches it to the open invoices and clears them.
The accounting uses two journal entries. A $5,000 sale on credit is recorded as:
| Account | Debit ($) | Credit ($) |
|---|---|---|
| Accounts receivable | 5,000 | |
| Revenue | 5,000 |
When the customer pays, cash is debited $5,000 and accounts receivable is credited $5,000. The detail by customer lives in the receivables subledger, whose total must agree with the control account in the general ledger.
Measuring and ageing receivables
The most common measure of collection speed is days sales outstanding (DSO):
A company with $900,000 of receivables and annual revenue of $7,300,000 has a DSO of days. If its standard terms are 30 days, customers are paying on average about two weeks late. DSO is one of the three parts of the cash conversion cycle.
An ageing report sorts open invoices by how long they are overdue, for example current, 1–30 days, 31–60 days, 61–90 days and over 90 days. The older a debt, the less likely it is to be paid, so the ageing drives both collection effort and the provision for bad debts.
Credit losses and accounting standards
Receivables are reported net of an allowance for expected losses. Under IFRS 9, trade receivables without a significant financing component use a simplified approach: the allowance always equals lifetime expected credit losses, often calculated with a provision matrix that applies a loss rate to each ageing bucket. In the United States, ASC 326, the current expected credit loss (CECL) model, likewise requires an allowance for expected lifetime losses rather than waiting for a loss to occur.
For example, if a company estimates loss rates of 1% on current invoices of $600,000, 5% on $200,000 that are 1–60 days overdue and 30% on $100,000 over 60 days, the allowance is dollars, and receivables are shown at $854,000. When a specific debt is judged uncollectible, it is written off against the allowance. Persistent write-offs signal weak credit risk control or concentration risk in a few large customers.
Financing and managing receivables
Because receivables tie up cash, businesses use several ways to turn them into money sooner:
- Factoring. Selling invoices to a factor, which advances most of their value and collects from customers, with or without recourse to the seller.
- Invoice discounting. Borrowing against receivables while keeping control of collections, a form of trade finance; a related bank product is known as bills purchased and discounted.
- Credit insurance and letters of credit. Protection against customer default, common in exports where a letter of credit shifts payment risk to a bank.
- Faster payment methods. Card payments, direct debit, instant bank transfers and virtual accounts shorten collection time and make payments easier to identify.
Receivables data feeds cash forecasting in treasury and the financial close in accounting. Auditors often confirm balances directly with customers, and unusual patterns, such as large credit notes after the period end, can point to errors or to revenue booked too early.