Accounts receivable (AR) is part of your small business’s payment collection process. Quite simply, the term “accounts receivable” refers to the “accounts” or cash that your business will “receive” from a customer. AR is a payment owed to your company by a customer, including selling an item to a customer on credit. Accounts payable (AP), on the other hand, are the monies you owe to someone else.
How Accounts Receivable Work
Knowing how AR works is important to understand your value as a company. You’ll need to know about the different ways AR is recorded to produce an accurate financial picture.
Is Having Accounts Receivable an Asset or a Liability?
Accounts receivable are recorded as an asset on your balance sheet. Assets are resources with “economic value.” and accounts receivable count as cash. Since accounts receivable will be converted into cash within a year, you can consider accounts receivable a current asset.
Because more receivables will lead to more cash flow for your business, they’re an asset to your company.
Do Accounts Receivable Use The Accrual Method Of Accounting?
Accrual basis accounting involves recording income you receive from a client when the invoice is sent. Even if payment hasn’t been received yet, you record this income in your ledger with this system.
When a transaction occurs, a receivable account is debited, and a revenue account is credited. When the transaction amount is paid, cash is debited and receivable is credited. However, if a customer does not pay its debt, the amount is marked as a credit loss or bad debts expense on an income statement, and the accounts receivable is reduced on the balance sheet.
How Does Credit Affect Accounts Receivable?
Many purchases today are made on credit, where actual payment comes at a later date. Payment information is delivered to the customer by way of an invoice, which specifies the date limit by which the payment should be made. Offering goods or services on credit can be advantageous to you, as customers who do not have the immediate cash to pay for goods or services may be more willing to make a purchase when payments occur at a later date. However, you are also at risk, as some customers may not make their payments when due.
Many businesses use what is called net 30, meaning that thirty days is the norm for receiving payments for items on credit after an invoice has been sent. After thirty days have passed, payments typically begin to accrue interest. Often, to increase payments, businesses may offer discounts if amounts are paid early.
What Is The Net Value Of Accounts Receivable And How Is It Affected By Bad Debt?
The net value of AR can be measured in two ways: the allowance method and the direct write-off method.
- The allowance method creates a contra-asset account, reducing balances of accounts receivable and provisioning for bad debt. This is accomplished by either analyzing each debt to determine if it will be unpaid or by creating a static percentage based on the number of debtors. Provisions for bad debt are contained in the bad debt expense account on an income statement.
- The direct write-off method, on the other hand, deals with concrete financial information. If it is apparent that customers will not pay off their debts, only then is accounts receivable reduced.
The use of the allowance method and the direct write-off method depends on how financial information is prepared. For example, while it is generally acceptable to use the allowance method when creating financial statements, it cannot be used when reporting income taxes, as the IRS will not allow businesses to anticipate losses in credit. The direct write-off method is the standard for reporting income tax. For financial statements, the two methods are sometimes able to be used together.
Bad debts expense accounts are temporary accounts listed on an income statement that close at the end of an accounting year. At the start of a new accounting year, balances in this account are distributed into retained earnings. This account covers debts that cannot be collected from the buyer because the buyer has gone out of business or simply not paid its debts.
In addition to bad debts, expense accounts are an allowance for doubtful accounts, which estimates the amount of uncollectible income from AR. Note that while bad debts expense accounts are temporary accounts, allowance for doubtful accounts is a permanent account that carries into the next accounting period. Whenever it becomes clear that a customer cannot pay an amount, allowance for doubtful accounts is debited while accounts receivable is credited.
What is Aging of Accounts Receivable?
The aging of accounts receivable is a report of unpaid customer invoices by date taken from the accounts receivable subsidiary ledger. It details how much a customer owes and how long the amount has been owed. Amounts are typically broken up into 30-day increments, with categories detailing payments past due less than thirty days ago, between thirty and sixty days ago, and more than sixty days ago.
The aging of accounts receivable can also show if your customers are frequently late in making payments and predict if the amount could turn into a credit loss. This can be helpful in determining the allowance for doubtful accounts, creating a probability that payments will not be collected based on customer histories.
A Bookkeeper Can Help Keep Your Accounts Receivable Straight
Between credit and bad debts and the aging of accounts, a lot more goes into AR than just entering invoices.
As a small business owner, it’s critical that your AR is accurate. But you may find it difficult to keep up with it when you’re busy running your businesses. Or, you may not feel comfortable doing it because you don’t have the financial background or insights to handle it accurately or with confidence. That’s okay, though, because it’s easy and affordable to outsource your AR entering and tracking along with the rest of your financial needs to us at Remote Books Online.
- We quickly and easily help you get your books up-to-date and ready for taxes, loans, or other transactions, for a clear picture of your business’s financial situation.
- Our convenient, online bookkeeping services start as low as $95 a month and are provided by certified QuickBooks ProAdvisors and Xero-Certified Advisors.
- We include accounting software and automated and secure encrypted monthly bank statement downloads.
If you’d like to try us out, we can enter all transactions, make necessary journal entries, and reconcile one month of your books for FREE. This way, you can experience exactly how we work and understand the benefits of having our team behind you.
If you’re a small business owner, you could try to keep up with your accounts receivable. Or, you can do it the easy, no-hassle way that sets you up for the future. Contact us for a quote today and learn more about how we can quickly and easily help you with your bookkeeping needs.