What is Accounts Receivable?
Accounts receivable refers to the balance of money which is due to a company for the goods sold and services rendered to its customers.? Receivable itself means to receive in future. read more about Difference between Accounts Payable and Accounts Receivable?
Companies carry out its sales on credit basis also for the ease of its customers so that they (customers) can make the payment for the goods purchased or services availed at a future date as per agreed terms. Companies extend the line of credit to its customers for a short time period ranging from one-two months to a complete financial year.
Cash is the most essential requirement for any company to carry out its day to day activities. A company can definitely survive in the market without earning profit for a small period of time but without cash, it is not possible to survive even for a day in the market, in fact, thinking about setting up a company without money is an absurd thought.
Therefore receiving accounts receivable very often or at regular interval of time will help a company to carry out its business operations with ease and without facing the lack of money.
After cash, accounts receivable happens to be the most liquid asset that is available with the company to carry out its daily operations.
Consider an example- Phoenix(customer) buys a truck worth $5000 from the Leyland Company on credit basis and signs a legal contract to repay the amount after a period of 60 days to the Leyland Company. Leyland Company will record the number of credit sales made in their accounts receivable.
During this credit sales, the inventory of the Leyland Company has decreased by $5000 so the company will increase its accounts receivable at $5000 to balance its financial statement.
After the completion of the allotted time period that is 60 days, Phoenix(customer) makes the payment of $5000 to the Leyland Company for the truck bought so now the cash available with the Leyland Company will increase by $5000 and the accounts receivable will decrease by $5000.
What if Accounts Receivable is not received?
First of all the customer is legally enforced to make the payment to the company for the goods purchased or services availed on credit from the company.
But if the customer makes default in making payment to the company as per agreed terms then it attracts penalty to the customer. And the company can also take the help of a collection agency to recover the accounts receivable from the customer.
Difference between Accounts Payable and Accounts Receivable
When you owe money to the third party which includes; individual, bank or company for the goods purchased or services availed on a credit basis as per agreed terms, this is known as accounts payable.
Accounts Payable is displayed on the balance sheet on the liabilities side as a current liability. In case of mortgage or loan, a legal contract is signed stating to pay back the loan amount in instalment as per the agreed terms.
When a company makes the sale of goods or render services to the customers on a credit basis as per agreed terms, this is known as accounts receivables. In the balance sheet, accounts receivable is shown on the assets side as current assets.
If it takes longer than a year for a company to receive cash then accounts receivable is recorded as long term asset on the asset side in the balance sheet. Example- The interest to be received from the investment made is treated as accounts receivable because interest will be received at a future date as per agreed terms.
The company gives discounts on paying early the due payment and the motive behind giving discounts to the customers is to receive the due payment before the agreed time and in order to avail the benefits of the discounts the customers make the payment early and that is how companies manage to receive their due payments within the time period.?
Why are Accounts Receivable important?
Accounts receivable is important because it leads to the generation of cash-in-flow. Accounts receivable helps in building strong credit relationship between the two parties. The important reason behind carrying out sales on credit basis also along with cash sales is to increase its customer reach and to make it more diverse.
In this way people who cannot buy goods by paying the cash immediately then they have the option to buy goods on credit basis and to pay for the same at a future date in instalments as per the agreed terms. Receiving accounts receivable frequently will enable the company to carry out its operations without facing any financial problem.
Accounts receivable also helps in preventing over cash flow and under cash flow.
Many companies allow only a portion of amount of sales on credit to its customers to maintain liquidity and also to reduce the amount of credit sales so as to save itself from the uncertainty as there are chances that it can become bad debts at a future date if the customer makes any default in making the payment so in that case, at least company has received a portion of the number of credit sales before only so the number of bad debts will be less.
But many companies carry out its sales on credit basis and customers are given a period of time to make the payment, and only on the agreed date of payment, the customer is bound to make the payment in full and not before.
The process involved in recording accounts receivable:
- Carrying out credit transactions ? Companies also have credit policies to carry out their sales. Two parties should come under the agreement to carry out the credit transactions. Under credit policy, the company gives a time period to its customer for making the payment of the goods purchased or services availed on credit.
- Before extending the credit the company should check the financial background of its customer whether the customer will be able to make the payment on time as per agreed terms or not to avoid loss of cash inflow.
- Generating invoices for its customer ? In credit transactions, the company generate an invoice of sales of goods made or services rendered.
- The invoice should carry all the details regarding the credit sales such as; the name of goods sold or service that is rendered, the amount for which credit transaction is done, the time period to make the payment for the credit transaction carried out between two parties. A copy of the invoice is given to the customer to make the payment as per agreed terms.
- Monitoring the payments received and payments due to be received ? An accountant is made to monitor the payments that are received and payments due from customers.
- All the details regarding the date of receiving the payment and the method through which payment is made are mentioned in the customer’s ledger account. The companies also generate timely reminder for the due pending to the customers so that they make the payment within the agreed time period.?
- Accounting of accounts receivable ? The accountant is responsible for recording all the due dates on which payment is to be received.
- Timely recording of all the accounts receivable will help is receiving the payments from the customers on time without making any delay. When the accounts receivable are recorded and payment is received then only the account of the customer is settled for good.
Management of Accounts Receivable
An efficient accounts receivable management will ensure that customers pay their dues on time without making any delay. Accounts receivable management will help the company not to run out of working capital and it will also ensure that there is no overdue of payments or non-payment of the due amount by the customer.
A sound accounts receivable management will reduce the risk of bad debts. And by timely generating the reminder to the customers for the due payments will help in receiving the payments on time.
The process involved in Accounts Receivable:
- To check the ability of the customers whether they can make the payments on time or not.
- To build strong credit relation.
- To address the complaints properly. After receiving the due payment, the balance of the accounts receivable should be reduced with the same amount.
- To monitor the risk involved in receiving the due payment.
- To prevent the occurrence of bad debts.