Questions in: Account Receivable

Accounts Receivable (AR) is a fundamental accounting term that represents the money a company is legally owed by its customers. It is considered a current asset on the balance sheet because these funds are expected to be collected within a year. AR is generated when a company allows a customer to purchase goods or services on credit, rather than demanding immediate payment. This process is initiated when the company issues an invoice to the customer, and that invoice’s value is then recorded as an outstanding receivable.

The management of Accounts Receivable is a critical function for any business, as it directly impacts cash flow and liquidity. A company with a large amount of overdue AR may face cash flow shortages, even if it is profitable on paper. Effective AR management involves several key activities: first, creating accurate and timely invoices to ensure customers have all the necessary information for payment. Second, establishing and enforcing a clear credit policy to mitigate the risk of non-payment. Third, and perhaps most importantly, implementing a robust collections process to follow up on overdue invoices. This often includes using an aging report, which categorizes invoices by how long they have been outstanding, to prioritize collection efforts.

The health of a company’s Accounts Receivable is a key indicator of its financial stability. A low AR balance, combined with a high collection rate, suggests strong financial health and efficient management. Conversely, a growing AR balance with a high percentage of overdue accounts can signal problems with a company’s credit policies, customer base, or collections process, and may lead to bad debt, where the company must write off the uncollectible amounts as a loss. In essence, Accounts Receivable is not just a bookkeeping entry; it is a critical financial lever that, when managed effectively, can be a major driver of a company’s financial stability and growth.