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.
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.
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".
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.
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.
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.
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.
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.
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.
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:
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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