Accounts Receivable Explained

If you boil it down to the very basics, the primary reason anyone starts a business is so they can be paid for something they are able to sell, or a service they can provide to customers.  It is this money coming in that allows the owner to pay for supplies, cover utilities, expedite payroll for employees, and much more.  What is left after all expenses have been paid is the profit the company records.

It seems rather easy; yet accurately recording Accounts Receivable and keeping up with debts owed is not a simple process.  There are three important and distinct processes with regard to Accounts Receivable.  First, receivables must be recognized.  This means recording the transactions as sales or sales revenue on the income statement, and increasing the accounts receivable account on the balance sheet.  

An invoice that indicates when payment is expected from the customer accompanies most transactions.  Net 30 days is the most common credit term offered.  This means that payment is expected 30 days after the sales invoice date.  In order to speed up payment processing, many companies offer a discount for quick turnarounds.  2/10 net 30 days is a common discount offered.  This means that the customer can pay 2% less if they pay within 10 days of the invoice date.  

The second process in Accounts Receivables is valuation.  This is the process of estimating how much money in the A/R account will not actually be collected.  Unfortunately, not all customers will pay their full invoice amounts on a timely basis, if at all, and some take discounts even though they pay in 30 days instead of the required 10 days.  Having a realistic value in your Accounts Receivables offers a better view of the overall financial health of the company.  

The third and final process involving A/R is disposition.  This requires a recording of a credit loss or bad debt expense on the income statement, and a reduction in accounts receivable on the balance sheet.  You will reduce business losses if you make sure your bookkeeper is monitoring your Accounts Receivable each month and follows up with any customers who have not paid their bills.  

A good bookkeeper will prepare an Aging Summary Report listing all customers who owe money and how old the debt is for your monthly review.  Customers who do not pay should be cut off from future purchases and you can determine at what point in time legal action should be taken to recover the funds owed.