Accounts Receivable

Definition

Accounts receivable refers to the money owed to a business by its customers for goods or services provided on credit. It represents a current asset on the company's balance sheet, as the business expects to receive the payments within a short period, typically within one year.

5 Must Know Facts For Your Next Test

1. Accounts receivable are a critical component of a company's working capital and cash flow management.
2. Effectively managing accounts receivable can improve a company's liquidity and reduce the risk of bad debts.
3. The aging of accounts receivable, or the length of time invoices remain unpaid, is a key metric for assessing the health of a company's credit and collection policies.
4. Offering early payment discounts or late payment penalties can incentivize customers to pay invoices on time, improving accounts receivable turnover.
5. Regularly reviewing and updating the allowance for doubtful accounts helps ensure the balance sheet accurately reflects the net realizable value of accounts receivable.

Review Questions

• Explain how accounts receivable relates to the preparation of financial budgets.
  • Accounts receivable is a crucial component in the preparation of financial budgets, as it directly impacts a company's cash flow projections. The expected collection of accounts receivable is a key input for the cash receipts budget, which forecasts the timing and amount of cash inflows from credit sales. Accurately estimating accounts receivable, including the allowance for doubtful accounts, helps ensure the cash budget accurately reflects the company's anticipated liquidity and ability to meet financial obligations.
• Describe the relationship between accounts receivable and the cash conversion cycle.
  • The cash conversion cycle measures the time it takes for a company to convert its investments in inventory and other resources into cash from sales. Accounts receivable is a critical component of this cycle, as it represents the time between when a sale is made on credit and when the customer pays. Effectively managing accounts receivable, such as by offering early payment discounts or implementing strict credit policies, can help shorten the cash conversion cycle and improve a company's liquidity and working capital efficiency.
• Analyze how changes in accounts receivable can impact a company's financial budgets and overall financial performance.
  • Fluctuations in accounts receivable can have a significant impact on a company's financial budgets and performance. If accounts receivable increase, it may indicate slower customer payments or a relaxation of credit policies, which can negatively affect cash flow and liquidity. Conversely, a decrease in accounts receivable may suggest improved collection efforts or more stringent credit terms, which can enhance cash flow and working capital. These changes in accounts receivable must be carefully considered when preparing financial budgets, as they can affect revenue projections, cash flow forecasts, and the company's ability to meet financial obligations and invest in growth opportunities.

Related terms

Credit Sales: The sale of goods or services where the customer is allowed to pay at a later date, rather than at the time of purchase.

Allowance for Doubtful Accounts: A contra-asset account that estimates the amount of accounts receivable that may not be collected, reducing the net realizable value of accounts receivable.

Cash Conversion Cycle: The length of time it takes for a company to convert its investments in inventory and other resources into cash from sales.