When it comes to the financial stability of a business, several key concepts must be understood. Knowing the difference between assets and liabilities, particularly when looking at accounts receivable and their presence on a company’s balance sheet, is among them.
Most companies will encounter the term account receivable at some stage, which is why it’s important to learn more about accounts receivable and whether or not it is considered an asset or liability. Here’s everything businesses need to know.
The definition of accounts receivable (A/R)
An account receivable is defined as “money due to a seller from buyers who have not yet paid for their purchases”. It is created when a business allows a client to purchase the goods or services on finance and will be balanced out once the company collects payments from the customer.
Accounts receivable may also be referred to as “A/R”, “accounts payable”, “unpaid invoice balances”, or simply as money clients owe and are due to pay at a future date. Therefore, it is important to understand them for the sake of accrual basis accounting in which businesses record revenue and expense liabilities when the transaction occurs rather than when the payment is made.
They may be used for B2C interactions when customers need a product but don't currently have the cash to buy it. a business may offer this as a 0% interest account or with a reasonable rate of APR. Alternatively, an accounts receivable account may surface when Company A lets Company B have a product now - perhaps due to their poor cash flow - but will collect payments at a later date.
Meanwhile, the term "note receivable" is when an assets account is linked to an underlying promissory note that states the terms of when the creditor will collect payment - including interest - from the debtor. The note receivable can also be used during legal proceedings, making it a good choice when high accounts receivable balance figures are involved.
What is meant by an "asset" or a "liability"?
In accounting terms, assets are items that a company owns and will bring in future economic benefits. Liabilities, on the other hand, are items that a company owes and will result in future economic outflows.
The key difference, then, is that one term relates to future incoming cash (assets) while the other is linked to future outgoing cash (liabilities).
Both assets and liabilities can cover transactions where a future cash payment is needed. For cash that is due to the business from a debtor, it is known as accounts receivable. Conversely, liabilities due to a creditor are recorded on the balance sheet as "accounts payable".
Is accounts receivable an asset?
Simply put, yes. Accounts receivable is considered an asset. This is because it represents cash that is owed to the company by customers.
While the monies may not be immediately available, they are still considered assets because the company's AR is a claim on future earnings. In other words, the invoice will eventually be converted to cash - even if this is not seen until a future reporting period.
Accrual basis accounting ensures that the assets column includes unpaid invoice balances as A/R, which aligns with the concept of having revenue reported at the point of transaction.
As long as the customer pays their invoice within a reasonable timeframe, the business will eventually receive the money that is owed to them. With this in mind, it will be filed as an asset account on the company's balance sheet.
Why is accounts receivable an asset?
From the perspective of a financial statement, assets are items that a company owns and will result in future economic benefits. Therefore, they should be recorded on the balance sheet in this manner with accounts receivable considered an asset.
Accounts receivable fall into this category because it represents money that will eventually be received by the business. The money can then be used to pay expenses, purchase inventory, or reinvest back into the business.
While accounts receivable is an important part of a company's assets, it's important to keep in mind that it is still a liability. This is because the money owed to the business by its customers is not technically theirs until it is paid.
If customers do not pay their invoices within a reasonable timeframe, the receivables turn into bad debt. This is when the accounts receivable becomes a liability, as it represents money that the business may never see.
Bad debt is an important consideration when managing A/R assets because it can have a significant impact on a company's bottom line.
Is accounts receivable revenue?
Many people believe that accounts receivable is revenue. However, this is not the case. Revenue is the money that a company has earned through the sale of goods or services. Accounts receivable is the money that a company is owed by its customers.
While accounts receivable can have an impact on revenue, it is not considered to be revenue itself. This is because revenue has already been earned, through monetary payments or cash equivalents, while accounts receivable represent money that is owed to the company.
The invoices are linked to future assets. However, they are currently considered unpaid receivables. Until this status changes, A/R cannot be included in your reported revenue figures.
Accounts receivable: asset, liability, or equity?
As already established, accounts receivable is not revenue. So what is it - an asset or a liability?
The answer is: it can be either one. Accounts receivable becomes an asset when the customer pays their invoice within the agreed-upon time frame. If the customer does not pay their invoice within the agreed-upon time frame, accounts receivable becomes a liability.
This is because the company now has to take action in order to receive payment, which may include hiring a collections agency, taking the customer to court, or a variety of other collection methods. Either way, the company has incurred additional expenses in order to receive its payment that would not have been incurred if the customer had paid on time.
Your DSO (days sales outstanding) will give you a good indication of whether your accounts receivable is an asset or a liability. A low DSO means that most of your invoices are being paid on time, while a high DSO indicates that many of your customers are making late payments (or defaulting on them).
It is important for businesses to keep track of their accounts receivable and accounts receivable turnover ratio. They can subsequently take action accordingly in order to minimize the amount of time that receivables are outstanding. This will help to improve cash flow and reduce the likelihood of having to write off bad debts.
Is net accounts receivable included in the current assets category of a balance sheet?
Because accounts receivable are usually converted to cash within one year, any receivable is an asset considered to be a current asset on the balance sheet. This is because the cash is only owed for a short period, meaning it should not be considered a long-term asset.
However, if a customer is significantly delinquent on their payments, the company may decide to write off the receivable as a bad debt. This means that it is no longer considered a current asset, but instead included under the liabilities category and classified as a loss on the income statement.
While the current asset is not recorded on the company's income statement, its inclusion on the balance sheet ensures that the cash tied up in the company's invoicing and services delivered without immediate payment will be accounted for.
Does accounts receivable count as a tangible asset?
Tangible assets, including current assets, normally refer to physical assets such as property and equipment. However, despite not being a physical asset, accounts receivable are still recorded as tangible assets.
This is because, once the invoice has been sent, the customer has an obligation to pay the company. The terms of payment and cash amount to be paid are then set in stone, meaning that the receivable becomes a fixed and measurable current asset.
In short, the money currently attributed to the company's account receivable will soon become a physical asset in the resources owned by the business. This is why A/R should not be recorded as intangible assets.
How to maximize the value of A/R balance
Now that we've established that the company's accounts receivable are, in fact, current assets, it's important to maximize their value. Otherwise, unpaid assets will become liabilities.
There are a few key ways to do this:
- By ensuring that creditworthy customers are being invoiced - This will minimize the risk of bad debt and late payment, meaning that you can focus your attention on other areas of the business. Conducting checks on new customers is a great way to ensure that they're worth invoicing. Low credit scores translate to an increased risk of A/Rs becoming future liabilities. Sometimes it is better to avoid doubtful accounts.
- By segmenting your customers - By grouping together customers with similar payment habits, you can better predict when payments will be made and plan accordingly. This also allows you to tailor your repayment terms to each group, which can incentivize prompt payment. It additionally helps you make allowance estimates for anticipated bad debt - because some late payments and non-payments are inevitable.
- By maintaining strong relationships with your customers - Good customer service and communication are key to keeping A/R low. If a customer is unhappy with the products or services rendered they've received, they're much less likely to pay their invoice on time (or at all).
- By sending invoices promptly - This gives your customers a shorter window to pay their invoice, which can help encourage prompt payment. If you're using accounting software or dedicated receivable automation software, you can automate this process to some degree.
- By offering early payment discounts - Many businesses offer a discount for customers who pay their invoice within a certain timeframe (usually 14 or 30 days). This can incentivize customers to pay their invoices sooner, which can help to improve your cash flow and reduce the risk of encountering future liabilities.
- By keeping on top of customer communication - If a customer is struggling to make a payment, the sooner you know about it, the better. This way, you can work out a plan together to ensure that the debt is paid off as soon as possible. it will go a long way to protecting the gross amount of revenue collected during the reporting period. Good customer communication can also help to build and maintain good relationships with your customers.
- By having a robust collections process in place - This will help to ensure that payments are made on time, and that any late payments are chased up efficiently. Automating your collections process can help to make it more efficient and effective.
- By setting clear payment terms - This will ensure that both you and your customer are clear on when payment is due, and can avoid any confusion or misunderstanding. Having clear payment terms can also help to reduce the number of late payments that you receive.
- By staying on top of collections - This will ensure that any outstanding payments are followed up as soon as possible, and that you are not out of pocket for too long. It is particularly important for high value tasks and clients. Being proactive is key to effective collections.
- By using technology - Utilising tools such as debtor management software can help you to automate your collections process, and stay on top of outstanding payments. This can free up time so that you can focus on other areas of your business. Technology has come a long way in recent years, and there are now a number of different software options available to suit businesses of all sizes.
By following these best practices, you can be sure that your accounts receivable assets are working hard for your business. And it will be reflected in your balance sheet too.
How Chaser can help
As one of the leading credit control software providers, Chaser is here to help you get paid on time, every time.
Chaser's software integrates with your accounting software to give you a real-time view of your A/Rs and provides automated chasing features so that you can get paid faster.
Chaser also offers credit checking and debtor tracing services to help you minimize risk when extending credit to new customers.
For more expert insights on receivables management, check out Chaser's archive of articles, or speak to one of Chaser's credit control experts.
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