What is Accounts Receivable?
Simply stated, accounts receivable is what customers still owe a business. More technically put, accounts receivable is the sum of outstanding balances owed to a business by third parties for goods delivered or services rendered, purchased on credit with terms of one year or less. Accounts receivable, often abbreviated “A/R,” or referred to as “trade receivable” or simply, “receivables,” is therefore considered a short-term asset on businesses’ balance sheets.
How is it monitored?
Businesses extend short-term, interest-free credit to customers to attract more sales. However, extending too much credit or extending it to parties unable to pay can hurt a business. Companies can measure and monitor their efficiency in collecting receivables by two chief measures: the accounting receivable ratio and accounts receivable days.
The accounting receivable ratio, also called the accounting receivable turnover ratio, tells you how many times over a given period a business collects its receivables. The higher the number, the more efficient a company is at collecting receivables. However, a very high number may indicate an overly onerous credit policy that potentially drives away sales. Inversely, a very low number indicates an overly lax credit policy or ineffective collections method. The ratio is expressed as follows:
Accounts Receivable Turnover Ratio =
Net Credit Sales/Average Accounts Receivable
- “Net credit sales” is the sum of all sales on credit less returns and less allowances.
- “Average accounts receivable” is the sum of starting and ending accounts receivable over a set period of time, divided by two.
Accounts receivable days, also called days sales outstanding (DSO), is the average number of days it takes a business to collect payment on its credit sales.
It is expressed as follows:
Accounts Receivable Days =
(Accounts Receivable/Total Credit Sales)
x Number of Days in Cycle