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Account Receivable – What is it? Functions, Process & How to Calculate Turnover Ratio?

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The term receivable stands for the payment of the amount received. This means that account receivable (AR) is the unpaid balance of money from your receivers/customers end for the products or services you sold to your customers. It represents any purchase that is based on customer credit and is shown on your balance sheet as an existing balance.

# What is Account Receivable?

Account receivable(AR) is the income or payment that the company will receive from its customers which is its goods and expertise on credit. Payment is usually made by the customer, with a credit period ranging from a few days to months or in some cases maybe a year. In other words, it is the amount your customer has given you in relation to end of credit balance. Account receivable is also known as debtors, trade debtors, bills receivable, or trade receivables.

# What Are the Functions of Accounts Receivable?

A receivable account is a general account used to track revenue earned by company accountants but has not yet been collected. This helps in balancing the funds given by the buyers to the business. Those buyers who make purchases on credit and agree to pay later. Collecting timely payments is very important for financial efficiency for a business.

  • Business Purpose:- Selling supplies or resale products is critical to the success of many companies, as some buyers do not have enough cash left to meet all their equipment and inventory needs. Providing customers with the ability to buy items, as they need and pay for them later, helps attract new customers  and create a repeat business with existing customers. Typically, businesses send invoices on account purchases that provide a small discount on paying the balance within 30 or 60 days. If payment is not received after 90 days, a late fee is often applicable as per agreement. 

  • Revenue Generation:- Accounts receivable represent your two types of revenue, the other being cash. Cash upfront is always ideal, but accounts receivable have many companies selling. In a contingency accounting system, companies recognize income earned at that time. This means that account purchases are considered revenue when purchases occur, not after payments have been collected. This strengthens sales and income. Revenue is reported on a company’s income statement.

  • Asset:- One of the largest current asset accounts is for companies selling accounts receivable. Current assets are those that are due within twelve months. The two major liquidity ratios, the current ratio, and the quick ratio show how well a business can cover its projected debt obligations. The current ratio is equal to current assets divided by current liabilities. A ratio of 2:1 is a good benchmark. The quick ratio is the same, but it removes the inventory balance from current assets because a ratio above 1:1 is ideal for trading inventory.

  • Collection:- Managers develop policies related to collections on accounts. The goal is to collect payments as soon as possible to maintain good cash flow and liquidity. Clear communication of policies in correspondence helps ensure timely payment, with an offer for faster payments and incentives for penalties for delayed payments. At some point, collection calls are used as a more vocal approach to receiving payments that have been delayed by more than 90 to 120 days. If payments become uncontrolled, the receivables should be written off as bad debt, which reduces revenue.

# Accounts Receivables Process 

  • Providing invoices to the customer on credit according to the credit policy in the receivable account, which gives details of the products and services taken on credit.

  • Recording the date of payment of the cost of those products and services on a credit

  • Follow a credit policy in the accounts receivable

  • Generating the overdue bills and the ones that are pending for the longest time.

  • Sending reminder letter with details of pending bills or friendly payment reminder

  • On receiving the payment, record the receipt and adjust the receivable accordingly

  • If there is any cash rebate for prepayment in the receivable account as per the Credit Policy, then relevant adjustments need to be made for the Account.

# Why is Account Receivable Important?

  • Accounts receivable are an important part of the company’s assets. 

  • It generates cash flow in the company’s books. This is very important for the company as it affects the future cash flow of the company.

  • The company often provides credit facilities to customers to make the transaction process easier and establish a strong credit relationship. This sometimes helps to provide much better for the company.

  • An investor can easily use the days of receivables to check the collection efficiency of the company.

# Benefit of Accounts Receivable

  • It can measure a company’s liquidity, a company’s ability to cover its short-term obligations.

  • The account receivable turnover ratio can be used to measure the number of accounts that receive the balance of receivables of their accounts in a financial year.

  • An excellent analysis of day sales will measure the average time taken by a company to take a balance attainable over a specific period of time.

  • Account receivables are a movable asset for a company, a company can ask a bank to assist with loans and use account receivables for security.

# What Kind of Account are Accounts Receivable?

Receivable refers to the amount of money we give from our client to a business for goods or services. Accounts receivable are recorded on your balance sheet as the current balance, with the balance of the account held for a few days, months, or year due to the debtor. If the account is receivable for more than one year to be converted into cash, it is recorded as long-term assets or notes receivable on the balance sheet. Under the contingency basis of accounting. The account is offset by an allowance for doubtful accounts, as there is a possibility that some receivables will never be collected. This allowance is an estimate of the total amount of bad debts related to the assets receivable.

# Accounts Receivable Turnover Ratio

The receivable turnover ratio, also known as the debtor’s turnover ratio, is an efficiency ratio that measures how efficiently your company is collecting revenue – and by extension, how efficiently it is using its assets. The receivable turnover ratio measures the receivable turnover ratio in the period in which the company collects its average accounts for the period receivable.

To calculate receivable turnover, Net credit sales are sales where the cash is collected at a later date. The formula for net credit sales is = Sales on credit – Sales returns – Sales allowances.

Average accounts receivable is the sum of starting and ending accounts receivable over a time period (such as monthly or quarterly) divided by 2. 

The formula for A/R turnover ratio is as follows:-

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

# Conclusion

Account receivable is the amount a company receives from its customers. It is the amount for goods and services that your customer owes, purchases made on credit. You will be called the account recipient for the outstanding balance in the general ledger. The outstanding balance in the account is stated on the company’s balance sheet. Account receipts occur when a customer pays the company’s money. An account is payable when a company lends money to its suppliers.


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