Accounts receivable

Definition

Accounts receivable refers to the money that customers owe a business for goods or services that have been delivered but not yet paid for. This asset is recorded on the balance sheet and represents a claim for payment, highlighting the company's expected future cash inflows.

5 Must Know Facts For Your Next Test

1. Accounts receivable are typically classified as current assets because they are expected to be converted into cash within one year.
2. The valuation of accounts receivable may involve creating an allowance for doubtful accounts, which estimates uncollectible amounts.
3. Companies often monitor their accounts receivable turnover ratio, which measures how efficiently they collect payments from customers.
4. An increase in accounts receivable might indicate higher sales on credit but can also signal potential collection issues if customers delay payments.
5. Proper management of accounts receivable is crucial for maintaining cash flow and overall financial health in a business.

Review Questions

• How does the establishment of an allowance for doubtful accounts impact the valuation of accounts receivable?
  • The establishment of an allowance for doubtful accounts directly impacts the valuation of accounts receivable by reducing its net book value on the balance sheet. This allowance represents an estimation of amounts that are not expected to be collected, reflecting a more realistic figure for potential future cash inflows. By doing this, companies can present a clearer picture of their financial position and ensure that their assets are not overstated.
• Discuss the relationship between credit sales and accounts receivable management in a business.
  • Credit sales significantly affect accounts receivable management because they increase the amount owed to the business by customers. When a company sells on credit, it must effectively manage its accounts receivable to ensure timely collection of payments. A strong management strategy might involve regular communication with customers, monitoring outstanding invoices through aging schedules, and implementing collection procedures, all aimed at maintaining healthy cash flow and reducing bad debts.
• Evaluate the consequences of neglecting effective accounts receivable management in a business context.
  • Neglecting effective accounts receivable management can lead to serious financial repercussions for a business. Without proper monitoring and collection practices, companies may face increased levels of uncollectible debts, negatively impacting cash flow and profitability. Additionally, failing to manage accounts receivable could result in strained customer relationships due to inconsistent communication about payments. In the long run, these issues may threaten the overall financial stability of the company and hinder its growth potential.

Related terms

credit sales: Credit sales occur when a business sells goods or services to customers with an agreement that payment will be made at a later date, increasing accounts receivable.

bad debt expense: Bad debt expense is the estimated amount of accounts receivable that is expected to be uncollectible, impacting a company’s income statement.

aging schedule: An aging schedule is a tool used to categorize accounts receivable based on the length of time an invoice has been outstanding, helping businesses assess credit risk.