What is Account Receivable?

. 9 min read
What is Account Receivable?

Functions, Process & How to Calculate Turnover Ratio?

Accounting is an important area for any business- be it small or large. The account management should be done with transparency and clarity to avoid any hassles in the overall business. Good accounting helps in the better financial management of the company and helps it achieve its goals.

Understanding what type of account is accounts receivable helps keep track of all the accounts that the company can expect from their customers. In the accounts receivable or AR, the revenue is used to support the operations of the organisation or the business. It keeps track of the overall performance of the company’s financial flow.

What do accounts receivable mean?

In the simplest terms, the account receivable can be understood as the payment that the company is expecting from customers. This payment can be made in any amount of time, ranging from a few days to a year. It is also known as debtors or bills receivables.

The accounts receivable turnover ratio is used as a main quantifier to track business accounting and its effectiveness. It determines if the company is managing credits well. Different companies may have different ways to manage it. A company is said to do well if it can collect the outstanding amount due to the accounting period.

What are accounts payable and receivable?

Accounts payable or AP is the opposite of AR and indicates the company’s capacity to acquire its own goods and services with high efficiency and minimum expense. It calculates how much money the business owes to other parties.

How to calculate turnover ratio?

To calculate the accounts receivable turnover ratio, take the company’s net sales and divide them by the average AR amount.

Net Credit Sales = (Sales on Credit) – (Sales on Returns) – (Sales Allowances)

Average AR = {(Initial AR) + (Final AR)} / 2

Therefore, the overall AR turnover ratio = Net Credit Sales/ Average AR

What are the functions and processes of account receivable?

It is important to have a high AR turnover ratio. The information indicates how long the customers take to make the payments and if the cash flow is managed consistently. A low AR turnover may indicate that the company is being too lenient with customers. Essentially, every turnover ratio should have a context that depends on the type of business that is being conducted.

1. Generation of revenues

The accounts receivable can give a good estimate of the company’s revenues.

2 types of revenues are- the one being paid upfront and the one that goes in credit.

While the first value is always more valuable, the AR value keeps the company going. Revenue is counted for all the purchases occurring, including those for the cash that is yet to be obtained. This revenue is thereby reported in the income statement of the company.

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2. Expands business opportunities

When companies provide the ability for customers to buy items on credit, it helps in attracting more customers. It also ensures that business is repeated with these sets of customers who have taken credit. Many companies can sell items for buyers who might not always have the full cash necessary to make the purchase, and hence the account goes to AR. Different policies can be made to ensure payments on time. Some may offer a discount if the payment is done before time, and some may charge a late fee.

3. Account collection

The collection of accounts is an important part of conducting any business. It is important that the cash flow is always maintained so that there is no loss of inventory and assets of the company itself. Good communication should be maintained with the customers regarding payment. Offers and discounts should be announced at times. There could be a system of initiating calls and subtly approaching customers if the payment is getting delayed. Uncontrolled payments can lead to bad debt, and hence revenues can decrease.

Process of AR

The following steps are taken for an accounts receivables process-

  • Invoices created for customers who take credit as per the credit policy of the company. It gives all the details of the products and services.
  • The date of payment is recorded of the products and services taken on credit.
  • The overdue bills are generated, including the ones that have not paid for the longest time.
  • Reminder letters are sent to customers for pending bills.
  • Once the payment is received, the receipt should be recorded, and the AR is adjusted.

Types of accounts receivables

There can be different types of accounts that require AR. If the customer needs at least one year to pay back the amount, the balance is recorded as long-term assets.

Doubtful accounts are also kept on an offset, and this is recorded to identify the receivables that may never be collected. This also goes into the total amount of bad debts recorded by the company.

Calculator, pen and glasses on finance sheet

Advantages of accounts receivables

While the AR policy may seem like a compromising situation for the company, there are several benefits that one can count on-

  • It gives a great analysis of the day sales that are conducted. It gives an approximate time for the company to attain a balance over a fixed period of time.
  • It is a measure of the liquidity of the company. Thereby, it can help estimate the company’s ability to accomplish its short-term goals.
  • The AR turnover ratio is used to measure all the accounts that can receive the receivables balance at the end of the financial year.
  • The AR is also a movable asset. Hence, they can be taken as security for any kind of financial assistance that the company may need.

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5) OkCredit: Simple, Paperless & Secure solution for businesses

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Q. What does a high AR turnover indicate for the company?

Ans. A high AR turnover ratio can be a great sign for many companies. It means that the company is getting most of the payments on time from their customers, and there is no loss of revenue. One can understand that the payment collection process of the company is highly efficient, and they have a good customer base, including most individuals who pay on time. It can also indicate that the company might have a conservative credit policy. The AR ratio should be taken with a clear understanding of the type of business to get a precise picture.

Q. Is a low AR bad for the company?

Ans. Depending on the type of business, a low AR may indicate several warning signals of the company. It can show that the collection process is not good enough. The customer base includes too many people who cannot pay for the products and services provided. The credit policies may be over-generous with minimum checks. Perhaps, the company is focusing more on sales rather than collecting payments. In some cases, a low AR may not be that bad if the management is aware of the long-term receivables and maintains connections with the customers for a long time.

Q. How does AR turnover indicate the efficiency of the company?

Ans. The AR turnover ratio indicates the customer management of the company and the credit policies. These systems are very important for the company to run smoothly and generate revenues in the long run. The account receivables generate cash flow for the company’s account books, affecting future cash flows. Providing credit facilities should be crucial to customers to have good relationships with customers who may repeat transactions. However, the collection efficiency is primarily important that indicates the final revenues.

Q. What is the importance of account receivable?

Ans. The account receivable can help estimate the overall management of revenue collection in the company. Any investor can check the value of AR turnover and make an investment by checking the company’s efficiency level. It is also a good indicator of the assets of the company. A high AR shows that the company has a good system of collecting payments and the customers are loyal and trustworthy. A low AR can indicate the opposite but still shows the level of sales that is made.

Q. How can the AR turnover be improved?

Ans. We need working capital management services throughout our business journey. You can even get working capital management strategies for your business. Still, under various circumstances, you would have to make changes in those strategies that an experienced person can only do.

Generally, it can be considered that a high AR turnover ratio is good for the company. This can be achieved by a good communication system between the company and the customers. Consistency should be prioritised at all costs by regular invoices and payment reminders. Payment options can also be made flexible for customers depending on their purchase and their loyalty. You can offer discounts and offers from time to time or give them other incentives. Digital automation of the process can also simplify the process to a great extent in the current times.