What Are Accounts Receivable (AR)?
Accounts receivable (AR) are the amounts of money owed to a business by its customers for goods or services that have been provided but not yet paid for. These amounts are listed as current assets on the balance sheet.
Key Points
- Definition: AR is money owed to a company in the short term.
- Creation: AR is created when a company sells on credit.
- Difference from Accounts Payable: Accounts payable is money a company owes to others, while AR is money to be received.
- Analysis: Companies use metrics like the accounts receivable turnover ratio and days sales outstanding (DSO) to assess AR.
Understanding Accounts Receivable
Accounts receivable are invoices for products or services that customers haven’t paid yet. They are considered assets because customers are legally obligated to pay. AR is a part of a company’s working capital and can be used as collateral for loans.
Accounts Receivable vs. Accounts Payable
- Accounts Receivable: Money customers owe to the company.
- Accounts Payable: Money the company owes to suppliers or other parties.
For example, if Company A cleans Company B's carpets and sends a bill, Company B records it as accounts payable, and Company A records it as accounts receivable.
Importance of Accounts Receivable
Accounts receivable indicate a company’s ability to cover short-term obligations. Analysts use the AR turnover ratio to see how often a company collects its AR, and DSO to see how long it takes to collect payments.
Example of Accounts Receivable
An electric company that bills customers after providing electricity records unpaid bills as AR. Many companies allow customers to buy on credit to make transactions easier.
What If Customers Don’t Pay?
If a customer doesn't pay, the company writes off the amount as a bad debt. Companies can also sell unpaid debts to third parties, a process known as factoring.
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