What is Accounts Receivable? Explained with an example

by Ledger Bench LedgerBench is your trusted accounting & bookkeepi

What is Accounts Receivable?

If a company has receivables that means they have created a sale, but have not collected money from the supplier. Many companies allow their clients to pay after receiving the service. Accounts receivable is the money owed to the company by its debtors.

Briefly, accounts receivables (AR) are the payments held by the business for supply of goods and services rendered to its customers who have ordered but not paid for the service. AR is in a form of invoice raised by the business and delivered to the customer for payment within a given time frame.

A typical example for accounts receivables is utility companies. A utility company bills their customers after providing the electricity. While the utility companies wait for the customers to pay the bills at the end of the month, these unpaid invoices are considered as accounts receivables.

The receivables should not be confused with accounts payable. AP is the debt company owes to its suppliers while AR is the debt of the buyers to the company.

Accounts Receivable are listed on a company’s balance sheet under current assets meaning the account balance is due from the debtor in one year or less. AR is any money due by customers for the purchase made on credit. It ranges for a few days to a fiscal or calendar year. Another word used for accounts receivable is trade receivables. Receivables may be offset by an allowance for doubtful accounts. It usually involves a single trade receivables account and a non-trade receivables account.

Example of AR:

Suppose Company A has supplied the services of carpet cleaning to its client for $200. The invoice is generated for an amount of $200, sale is recorded. Now the client Z is due to make the payment to Company A. In such a case, Company A will create an entry of $200 as Accounts Receivables from it’s client Z because the client Z will pay that amount before the period expires. If not, company A will charge a late fee or hand over the account to the collections department.

Most company’s offer services on credit to its special clients. Once the payment is made, the cash segment in the balance sheet will increase by $200 and the accounts receivables will be decreased by the same amount as the customer has made the payment.

How Does Accounts Receivable Work?

Create an invoice for the services rendered:An invoice is a document provided to the customer, details of the product or services that has been rendered. Your invoice must contain the following information:

Date
Customer information
Services provided
Due amount
Contact details
Payment terms

Debit the account receivables from the amount due from customers and credit sales for the same amount

Collect payment from the customer

Debit cash to show an increase due to the payment and credit accounts receivables to reduce the amount owed by your customer.

There are times when the customer fails to make the payment on time or on the due date. Take the following measures to ensure timely payments received by the company:

Use a reliable collection agency
Have an efficient follow up for late payments
Reward customers who pay on time by offering discounts
Penalize customers for late payments
Keep better track of these accounts with an accountant or an outsourcing firm.

Accounts Receivables cycle:

AR cycle arrives as soon as you agree to provide the customer, goods or services on credit basis and in return he promises to pay in the future. In short, you allow them to take the possession of product or service before they pay you. If your business accepts a credit card, the credit card company will manage the risk. But if your customer pays through cash/check then your company will verify payments and risk. The cycle includes the following:

Customer Making the Purchase
Creating invoice for the customer
Send Invoice
Offer discounts for early payments or late fee payments
Receive the payment

Summary:

Accounts Receivables are the dues to a firm for supplying goods and services but not yet paid by its customers.
AR is listed on the balance sheet of a company under current assets since there is an obligation for the customer to pay the debt.
It is created when a company agrees to allow their buyers purchase goods/services on credit basis.

Reference URL - https://ledgerbench.wordpress.com/2020/04/22/what-is-accounts-receivable/