What are Receivables?
The term receivables is short for accounts receivable (A/R), which are amounts bought by customers for a company's goods and services.
How Do Receivables Work?
Company XYZ sells $1 million in widget parts to a widget manufacturer and gives that customer 60 days to pay for those parts. Once Company XYZ receives the order and/or sends the parts, and/or sends the customer an invoice, it will decrease its inventory account by $1 million and increase its receivables by $1 million. When 60 days has passed and Company XYZ is paid, it will increase cash by $1 million and reduce its receivables by $1 million.
Receivables are assets, and as such, they appear on the balance sheet. In particular, receivables are current assets, meaning the amount owed is expected to be received within the next 12 months.
When receivables go down, this is considered a source of cash on the company's cash flow statement, and as such, it increases the company's working capital (defined as current assets minus current liabilities). When receivables go up, this is considered a use of cash on the company's cash flow statement because the company is 'stretching out' the time it takes to receive money owed to it and thus is using cash more quickly.
Why Do Receivables Matter?
Receivables are an important factor in a company's working capital. If it's too high, the company may be lax in collecting what's owed to it and may soon struggle to find the cash to pay the bills; if too low, the company may unwisely harm customer relationships or not offer competitive payment terms. In general, receivables levels correspond to changes in sales levels.
Companies can sometimes use their receivables as collateral for borrowing money. The level of receivables also affects several important financial-performance measures, including working capital, days payable, the current ratio, and others.
It is important to note that uncollectible receivables do not qualify as assets (these uncollectible amounts are reclassified to the allowance for doubtful accounts, which is essentially a reduction in receivables); thus, companies usually allow only creditworthy customers to pay days, weeks, or even months after they've received the company's services or goods. Sometimes companies sell their receivables for cents on the dollar to other companies that focus solely on collecting the owed amounts.
