There are three types of accounts receivable recognized in the accounting practice. Accounts receivable (AR) refers to balances of money owed to a company for services and goods that have already been delivered or used by customers, but payment has not been made for them. An accountant lists AR on balance sheets as a current asset. Accounts receivable is an amount of money customers owe for purchases they made on credit.
For any company, its accounts receivables refer to outstanding invoices that customers have yet to pay. The phrase refers to accounts that a company has the right to receive since the products or services have already been delivered to its customers. So, AR represents credit the company has extended to a customer. Usually, the company has predetermined and explained its terms and the consumer knows they have a specific, usually short, time frame to pay the debt. The time frame may vary between company policies and it might range from just a few days to a fiscal year.
Accounts receivable are recorded as an asset on the company’s balance sheet. It is done this way since the customer has a legal obligation to pay. Also, AR is considered current, rather than future assets since the balance is due within one year or less. When a company has receivables, it means the sale was made on credit, but the money has not come in from the purchaser. Essentially, the company accepted the equivalent of a short-term IOU from its customer.
The primary differences in the types of accounts receivable are when the company expects to be paid for the products or services rendered.
There are three types of accounts receivable:
|Notes receivable is a balance sheet item that is the value of a promissory note that the business is owed and expects to be paid for.
|The term is used on the balance sheet and represents a current asset for the company.
|Examples include any product or service purchased on credit with a specified payment plan. This could be large machinery or custodial services paid on a monthly basis.
Uncollectible Accounts Receivable
|Loans, receivables, or other debts that are not going to be paid by the debtor.
|These types of AR occur if a debtor declares bankruptcy or closes before paying off the debt. It is reflected on income statements and reduces the profits.
|Examples include a company going bankrupt and being unable to pay. Or a company that ordered a product that didn’t sell, therefore they cannot pay the debt.
|Other receivables are included in current assets on a company’s balance sheet. They are residual trade or non-trade receivables that are uncommon and lack classification.
|Companies need to record other receivables to balance their sheets, but these assets are usually minimal or insignificant.
|Other receivables include salary and interest receivables, tax refunds, advances to employees, and loans made to individuals or companies.
Which Type of Accounts Receivable is the Most Common?
The most common type of accounts receivable is notes receivable. It’s not all that different from AR, except for the payment deadlines. Normally, a customer has a one to two-month window to pay invoices or promissory notes. However, with notes receivable, the payment due date is extended. The extension is usually a year or longer.
When a note is due inside of a year, the note receivable is part of a company’s current assets. This is how the accountant enters it on the company’s balance sheet. But should the note give the debtor over a year to pay the debt, then the receivable is a long-term asset.
Notes Receivable is popular with businesses because giving customers more time to pay a debt can make it more likely to be paid. Many businesses rely on a supply chain to maintain profitability. Having more time to pay debts allows them time to do business and make a profit from which the debt can be paid.
Which Types of Accounts Receivable can have Their Due Date Extended?
Uncollectible accounts receivables are not expected to be paid by customers since they cannot settle the debt by payment. Other receivables and notes receivable are based on an invoice. When an accountant sets them up, they will record the invoice and due dates. The invoice date corresponded to when they occurred or the date the pledge to pay was made. The due date is when the payment is expected to be completed.
Most companies have established due dates for debts incurred by customers. They may set the due date for 30 days after the service was performed or goods were sold. But this date may be adjusted for notes receivables and other receivables. However, when a company adjusts due dates, it can pose numerous problems and affect its assets and cash flow.
Why is Accounts Receivable Important?
Accounts Receivable play a major role in determining a company’s assets. It’s essential for generating cash inflow and displaying it in the company’s books. Why is this so crucial? Because the future cash flow of a company is affected by AR. Companies provide credit to help their customers’ transaction process. Additionally, extending credit to a customer helps build a strong business relationship with them. It can also mean being able to get better deals. Investors like seeing this because they can check how efficient the company is at collecting its AR funds. If they have a good track record, investors may become more interested in investing in the company.
Investors study a company’s financial statements to assess its revenue, earnings per share, and net income. Investigating the revenue and profits of a company gives a good picture of its overall financial health. However, analyzing their accounts receivables gives more depth to the analysis. Why? Because AR measures the money owed to a company for services or products that have already been provided. AR also allows investors to obtain a better sense of the stability and liquidity of a company.
What are the Benefits of Accounts Receivable?
Tracking accounts receivable is critical for a business when it comes to managing cash flow. Even if sales are going well for a company, if their accounts receivable continues to grow, and customers don’t pay fast enough, it can still mean trouble. This is a good example of why fast growth is challenging for smaller companies. They may be making sales and delivering products, but without getting paid fast enough, eventually, there won’t be cash in the bank.
This is precisely the benefit of accounts receivable. It helps businesses stay on top of their financial situations, so they are sure to collect monies owed to them. Efficiently tracking accounts receivable provides how much all customers owe a business. But it also helps track which customers may be running behind on payments. This knowledge is useful for helping to decide which customers need to be chased down in order to keep the bank account full and operational.
When does a Company Collect an Account Receivable?
In short, as soon as possible and reasonable. Collecting accounts receivable is a critical part of running a business. Companies need some type of cash flow to operate. Collecting on AR is a stream of revenue that is necessary. Most of the time, companies try to collect on accounts receivable in 30 to 90 days.
How will I Know Which Type of Accounts Receivable to Use?
Choosing which type of accounts receivable to use depends mostly on how and when the invoices will be paid. Notes receivable is used for monies that are expected in the near future, especially inside the next 12 months. Other receivables are used for residual, negligible amounts that don’t fall into any specific time frame. Uncollectible accounts receivables are used for instances when a customer is not expected to pay at all.
How to determine which type of accounts receivable to use:
- Use Other Accounts Receivables for an advance, prepayments, prepaid insurance, and non-trade receivables that are expected to be paid for in the coming 12 months.
- Use Notes Accounts Receivables for tracking and managing debt and payments from customers.
- Use Uncollectible Accounts Receivables for Former customers who are unable to pay their debt.
Is Accounts Receivable a Loan?
Accounts receivable are not necessarily a loan. They are more like an advance. However, they are often structured like a loan that must be paid back. Loans are structured in a variety of ways depending on the financier. Unlike a loan, accounts receivable cannot be sold.
Is Accounts Receivable Considered Revenue?
No. Accounts receivable is considered an asset since it represents money that is owed to the company. What is revenue? Revenue is the money held by the company, therefore AR is not revenue. AR is represented on different financial statements than revenue. Accounts receivable act as a placeholder for funds until the company receives the compensation it is due for the goods or services.