What is accounts receivable?

Accounts receivable (AR) definition

Accounts receivable refers to the amount of money owed to a business by its customers for goods or services that have been delivered but not yet paid for. This is usually recorded as a current asset on a balance sheet.

AR is opposite to accounts payable, which refers to the amount of money that a business owes to its suppliers or vendors for goods or services that have been received but not yet paid for.

What can businesses learn from their accounts receivable?

Businesses can learn a great deal from their accounts receivable, as it serves as a valuable indicator of the company’s financial health and efficiency. By analysing their accounts receivable, businesses can gain insights into their customer payment trends, identify potential cash flow issues, and assess the overall effectiveness of their credit and collection policies.

Cash flow efficiency

A core function of accounts receivable is its direct impact on cash flow. The AR turnover ratio (how quickly you collect payments) is a crucial metric. A high turnover indicates faster collection and better cash flow. Conversely, a low turnover suggests slow collections, potentially leading to cash flow shortages and hindering your ability to meet short-term obligations (liquidity).

Invoice processing

One key lesson that businesses can learn from their accounts receivable is the importance of timely invoice processing and follow-up. Delays in sending out invoices or following up on overdue payments can significantly impact a company’s cash flow and create unnecessary financial strain. 

Creditworthiness

Analyse AR data to identify patterns in customer payment behavior. This can inform future creditworthiness assessments and potentially refine your credit approval process for new customers.

Potential liquidity risks

High AR balances can tie up significant cash, impacting a company’s liquidity. Reviewing accounts receivable can help identify potential liquidity risks by highlighting outstanding receivables that may not be readily converted to cash. This allows for proactive measures like stricter credit policies or exploring alternative financing options.

Overall, accounts receivable can provide valuable insights into a company’s financial performance and help businesses identify areas for improvement in their credit and collection processes. By leveraging this data effectively, businesses can optimise their cash flow, minimise bad debt, and improve their overall financial stability.