Definition
Accounts receivable (AR) is the total amount of money owed to a business by its customers for goods or services that have been delivered but not yet paid for. It appears as a current asset on the balance sheet because the expectation is that payment will arrive within a defined period, typically within 12 months.
How Accounts Receivable Works
When a business sells on credit, it raises an invoice and records the amount as accounts receivable. The customer becomes a debtor until that invoice is settled. A wholesale supplier that ships $50,000 of goods to a retail chain and issues a 45-day invoice will carry that $50,000 under AR until payment clears.
Managing the Collections Process
AR management centres on the collections process. This involves sending invoices promptly, following up on overdue accounts, and applying consistent credit policies that determine which customers qualify for credit terms and how much credit they receive. Businesses that issue invoices late or fail to follow up on overdue accounts often find themselves with a cash flow shortfall even when sales are strong.
Key Accounts Receivable Metrics
Key metrics used to monitor AR health include days sales outstanding (DSO), which measures the average number of days it takes to collect payment after a sale. A DSO of 30 days means the business is collecting payment roughly once a month. A rising DSO is a warning sign that customers are paying more slowly or that the collections process needs tightening.
Bad Debt and Invoice Factoring
Bad debt is a real risk in any AR portfolio. If a customer becomes insolvent or simply refuses to pay, the business must write off that receivable as a loss. Maintaining an allowance for doubtful accounts, based on historical collection rates, gives a more accurate picture of actual AR value on the balance sheet.
For small businesses especially, AR represents a tangible financial asset. Some businesses use invoice factoring, selling their outstanding receivables to a third party at a discount, to access cash faster rather than waiting for payment terms to expire.