Accounts receivable are a part of a company’s assets that represent the money that customers owe to the company for goods or services received but not yet paid for. In other words, it is the amount of money that is owed to a company by its customers. It is recorded on a company’s balance sheet as a current asset. Meaning that it is expected to be converted into cash in the near future.
Types of Accounts Receivable
You can divide accounts receivable into two categories: trade receivables and non-trade receivables.
Trade receivables are amounts owed by customers for goods or services sold by the company. They are the most common type of accounts receivable and are an essential part of a company’s operations.
Non-trade receivables, on the other hand, include other types of receivables, such as loans to employees or advances to suppliers. Non-trade receivables are not directly related to a company’s core business operations. Their management is often less critical than that of trade receivables.
Calculation of Accounts Receivable Turnover
The accounts receivable turnover ratio is a key metric used to measure how quickly a company is collecting its outstanding receivables. To calculate it, you divide net credit sales by the average AR balance during a specific period.
The accounts receivable turnover ratio is a critical metric for businesses. It helps to evaluate how well they are managing their outstanding receivables. A high turnover ratio means that the company is efficiently collecting its outstanding receivables. Whereas a low ratio indicates that the company may be facing difficulties in collecting its outstanding receivables.
Understanding the Importance of Managing Accounts Receivable in Business Operations
Impact on Financial Statements
A company reports accounts receivable as an asset on its balance sheet. Changes in accounts receivable can impact the company’s financial statements. For example, an increase in accounts receivable may indicate that the company is selling more goods or services, but it may also suggest that the company is having difficulty collecting payment.
Changes in accounts receivable can also affect a company’s income statement. When a company sells goods or services on credit, it recognizes revenue immediately, but it does not receive the cash until later when the customer pays. Therefore, changes can affect a company’s revenue, gross profit, and net income.
Impact on Creditworthiness
Lenders and investors may review a company’s AR to assess the company’s ability to generate cash flow and manage its working capital effectively.
A high level of accounts receivable may suggest that the company has a high level of credit risk. This may affect its credit rating. A low level of accounts receivable, on the other hand, may suggest that the company has efficient collections procedures and may improve its credit rating.
Maximizing Cash Flow through Effective Accounts Receivable Management
Maximizing cash flow is essential for any business, and effective accounts receivable management plays a critical role in achieving this goal. By managing accounts receivable effectively, businesses can improve their cash flow by collecting payments more quickly and reducing the risk of bad debts. To achieve this, businesses need to implement efficient processes for invoicing, payment collection, and follow-up on outstanding balances. Numerous businesses opt for invoice factoring as a means to achieve this. They can also consider offering incentives for early payment and using automated payment processing systems to streamline the payment process. By adopting these strategies, businesses can ensure that they receive payment for goods and services promptly, which in turn helps to maintain a healthy cash flow and overall financial stability.