Accounts Receivable (AR)
What are Accounts Receivable (AR)?
Accounts receivable (AR) are amounts owed by customers for goods and services a company allowed the customer to purchase on credit.
Said another way, when a company delivers a product or service to its customers, in many instances those customers do not pay immediately. Instead, they might have, for example, a 30 or 60-day period before they're required to pay the invoice for those goods or services. From the perspective of the company that sold the products or services, the money owed to it is referred to as accounts receivable.
Accounts Receivable Example
Let's assume that Company XYZ sells $1 million of 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 decrease its inventory account by $1 million and increase its accounts receivable by $1 million. When 60 days has passed and Company XYZ is paid, it increase cash by $1 million and reduce its accounts receivable by $1 million.
Why do Accounts Receivable matter?
Accounts receivable is an important factor in a company's working capital. If it's too high, the company may be lax in collecting what's owed too it and may soon be struggling to find the cash to pay the bills; if it's too low, the company may be unwisely harming customer relationships or not offering competitive payment terms. In general, accounts receivable leciels correspond to changes in sales levels.
Companies can sometimes use their receivables as collateral for borrowing . The level of accounts receivable also affects several important financial-performance measures, including , days payable, the current ratio and others.
It is important to 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.