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Accounts Receivable – Meaning and its Management

Updated on: Jun 16th, 2022


8 min read

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A sale is realized as and when the invoice is generated but usually, a time period is provided to the customers for the payment of the amount due. This practice of conducting business on credit terms give rise to Accounts Receivable (AR) in the financial statements.

This credit facility is laid down to ensure a smooth flow of the working capital into the businesses. There are complexities involved with the accounts receivable i.e its management, the process of recording in financial statements, credit period etc.

What is Accounts Receivable?

The word receivable stands for the amount of payment not received. This means the company has extended credit facility to its customers. Accounts receivable is the money that a business has a right to receive after a certain period of time when the business has sold goods or services on credit.

For example, the accounts receivable is the record of fact that a company has done some work for customer X and that customer X owes money to the company. Generally, the credit period is short ranging from a month or two to a year.

Why are Accounts receivable important?

The businesses usually have invested money in selling a product or delivering a service. After selling the goods, the inventories reduces and in turn businesses need an asset to balance the financial statements. Either that assets are cash-in-hand or receivables in case of credit sales and that’s why accounts receivable appear in the assets side of the balance sheet. As accounts receivables form a major part of the organization’s asset, it leads to the generation of cash in-flow in the books of the organization.

The idea behind providing a credit facility to the customers is to facilitate and ease the process of the transaction and establish a strong credit relation between the parties involved. It may lead to better deals or increase the chances of improving the working capital management.

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How is Accounts receivable recorded in the financial statements?

Usually, the businesses expect to receive money in the future, so it is to be added to the assets in the financial statement of the business. The accurate record keeping of this money that is receivable (accounts receivable) in the books of accounts are required to avoid any default in the payment due. 

Few pointers connected to recording accounts receivable are as follows :

Establishing the practice of credit transactions

The business may establish a practice of providing a credit policy to its buyers. This credit can be extended for a specified time period and any default in this payment usually attracts penalty. This practice of credit facility requires two parties to come to an agreement on the terms and conditions for such credit transactions.

The provider of this facility should also verify the paying ability of the customer before agreeing to any terms and conditions.to prevent loss of cash inflow.

Generating invoices for the customer

The businesses are required to generate invoices of the sales made or services delivered. The invoice should have details of the cost of goods and services sold to the customers. This generating of invoice ensures the recording of the credit transaction clearly in the accounts of the business. Further, a copy of the invoice is given to the customer to make the payment as per the agreed terms.

Tracking the payments received and the payment that is due to be received

An accountant is required to track the payments received or due from the customers. The details of the method of payment and date of receiving payment have to be recorded in the customer’s ledger account. This ensures correctness of accounting of the credit amount. The businesses shall also generate timely reminders for dues pending to the customers.

Accounting for the accounts receivable

The accountant or the person responsible for taking due care of the accounts receivables must record all the due dates of the payments to be received. The timely and prompt recording of the accounts receivable leads to receiving the payments on time from the customers. Once the account receivable is recorded and payment is received, the account for the said party can be settled for good.

What is Accounts receivable management?

Accounts receivable management is the process of ensuring that customers pay their dues on time. It helps the businesses to prevent themselves from running out of working capital at any point of time. It also prevents overdue payment or non-payment of the pending amounts of the customers. It builds the businesses financial and liquidity position.

A good receivable management contributes to the profitability by reducing the risk of any bad debts. Management is not only about reminding the customers and collecting the money on time. It also involves identifying the reasons for such delays and finding a solution to those issues.

What is the process involved in the Accounts receivable management?

An Account receivable management process involves the following : 

  • Credit rating i.e the paying ability of the customers shall be reviewed before agreeing to any terms and conditions
  • Continuously monitoring any risk of non-payment or delay in receiving the payments
  • Customer relations should be maintained and thus to reduce the bad debts
  • Addressing the complaints of the customers
  • After receiving the payments, the balances in the particular account receivable should be reduced
  • Preventing any bad debts of the receivables outstanding during a particular period.
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