Accounts receivable revenue can be confusing for small businesses because it’s money that’s owed but hasn’t yet been paid.
When you offer customers or clients goods and services on credit, your accounts receivable keeps track of what's owed to you and when. A solid accounts receivable process can improve cash flow by making sure you get paid on time according to the payment terms of your contracts with customers.
But how are accounts receivable recorded on your balance sheet? Keep reading to find out more about the definition of accounts receivable as it relates to assets.
Table of Contents
- Is accounts receivable an asset?
- Does accounts receivable count as revenue?
- What are other assets for small businesses?
- Limitations of the accounts receivable turnover ratio
- 5 tips to improve your accounts receivable turnover ratio
- Track and improve accounts receivable turnover ratio with accounting software
Accounting Definitions Cheat Sheet
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Asset |
Something your company owns |
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Revenue |
Your company’s income |
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Liability |
Debt your company owes |
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Equity |
Leftover assets after liabilities |
Is accounts receivable an asset?
Yes, accounts receivable (AR) is an asset account on your balance sheet. For businesses that use accrual accounting (as opposed to cash basis accounting), an account receivable is an asset that will soon be converted to cash, usually within 30, 60, or 90 days.
If your accounts receivable assets takes longer than one fiscal year to be converted to cash, it's considered a long-term asset that may be offset by what's called “allowance for uncollectible accounts", or doubtful accounts.
Doubtful accounts estimates the amount of bad debt your business will see in any given time period. Bad debt is AR your business can't collect from customers, either because they won't pay you or they've gone bankrupt.
The difference between your gross accounts receivable account and your doubtful accounts is the accounts receivable your business can expect to convert to cash.
Compare this AR to accounts payable, which is a liability.
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Does accounts receivable count as revenue?
Yes, in accrual accounting, AR is recorded as revenue on the income statement. It's considered revenue as soon as your business has delivered products or services to customers and sent out the invoice.
You need to be diligent about tracking your company's accounts receivable because it's considered revenue. If you're not tracking your accounts receivable with automation, you're also not tracking cash — and that's where your business can get into trouble.
When you are extending credit to customers for goods and services, you're trusting that they'll deliver a future cash payment on your payment terms — but that's not always the case. Keep a close eye on your ratio between your AR and cash on hand, as that will tell you whether or not you can anticipate any cash flow issues.
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What are other assets for small businesses?
Business assets are anything your business owns, but that can come in many forms. You’ll want to categorize your assets as “current assets”, “fixed assets”, and “other assets.
A current asset is utilized in the short-term. They’re the assets you spend on running your business day-to-day, and they’re usually spent within a year.
Fixed assets are long-term. Physical assets like property and equipment are “fixed” because they last a lot longer than one fiscal year; in fact, you probably really depend on them to run your business for the long haul.
Examples of Current Assets
Examples of current assets include:
- Cash on hand/cash equivalents
- Accounts receivable
- Equity or debt securities
- Inventory
- Prepaid expenses — goods or services you’ve paid for but have yet to receive in full
Examples of Fixed Assets
Examples of fixed assets include:
- Real estate and land
- Vehicles
- Office furniture
- Equipment
The above are all tangible assets - keep in mind there are also intangible assets, which are things like patents, brands, trademarks, or copyrights. These don't appear on your balance sheet.
See a complete list of asset classifications here.
How to analyze accounts receivable
Accounts receivable are one of the most important metrics for businesses. They show how much cash a business generates and how profitable it is. But there are many different ways to analyze accounts receivable, and some methods work better than others. Here are three common accounting techniques used to evaluate accounts receivable:
- Balance Sheet Analysis
- Income Statement Analysis
- Cash Flow Analysis
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The accounts receivable turnover ratio
Accounts receivable turnover ratio (AR/TVR) is one of the most important metrics used in managing a company's finances.
To find the AR/TVR, divide net credit sales by average AR. To ensure accuracy, companies should review their AR/TVR calculations periodically.
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What can accounts receivable ratio tell you?
Accounts receivable ratio can help determine whether or not your customer base will pay back money owed. This metric helps you understand what percentage of invoices have been paid off.
The higher the ratio calculated, the better the business is at collecting customer payments. In this case, you might want to consider offering discounts to encourage early payment.
A low ratio indicates that your customers tend to pay back late. Your best bet is to minimize clients with high ratios because you'll likely end up having to chase payments down.
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Calculating accounts receivable/accounts payable turnover ratio
The Accounts Receivable (AR) ratio and Accounts Payable (AP) ratio are used to evaluate the financial health of a company. To calculate this ratio, you must divide the number of customer bills in a month by the amount of bills you owe in a month.
For example, assume Company B had $1 million in accounts receivable and $500,000 in accounts payable outstanding at the end of the month. If Company B paid off its accounts payable within 30 days, it would have an AR turnover ratio of 0.5. However, if it took 60 days to pay down its accounts payable, the AR turnover ratio would be 0.6.
A high AR turnover ratio indicates that a company pays its bills quickly and effectively. Conversely, a low AR turnover ratio suggests a company takes longer to convert its accounts payable into cash than it does to collect money owed to it. Companies with lower ratios are usually less efficient in paying their bills.
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What is a good accounts receivable turnover ratio?
Accounts receivables turnover ratios measure how often customers pay bills on time. If you have high AR turnover rates, it could indicate that there is something wrong with your customer service or collections processes.
You might find yourself paying too much money to vendors or having trouble collecting payments from clients. On the flip side, an accounts receivables turnover rate under 30% could indicate that you are overpaying your vendors or that your customers aren't paying their invoices on time.
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Limitations of the accounts receivable turnover ratio
Accounts receivable turnover ratios are used to measure how quickly companies collect money owed to them, but there are several limitations to relying on this number alone:
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No insight into profitability
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Does not consider that older invoices take longer to collect
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No information about customer behaviour
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Doesn't account for seasonal fluctuations
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5 tips to improve your accounts receivable (AR) turnover ratio
Accounts receivable (AR) turnover ratio is one of the most important metrics used to measure the effectiveness of your collection efforts. If you want to improve your AR turnover ratio, start by following these five tips.
- Make sure invoices are sent out on time or before the invoice due dates.
- Always state payment terms. For example, "Payment within 5 days of receipt."
- Offer multiple ways to pay – such as credit cards, checks and online checks, bank transfers, etc.
- Don't wait until customers are days to weeks behind before starting collections; start collecting immediately.
- Offer discounts for paying in cash. This will help you decrease your costs of accounts payable.
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Track and improve accounts receivable turnover ratio with accounting software
Accounting software helps companies keep track of their finances, including managing their cash flow. This includes tracking how much money customers owe them, and how long it takes to collect those debts. However, many small businesses don't know what steps to take to increase the amount of money collected before the due date. They simply wait for customers to pay up, even though there could be better ways to handle the situation.
Effective accounting software should provide tools to improve your AR turnover ratio. For example:
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Setting up automatic reminders to contact customers to collect payments.
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Automating sending invoices, accepting payments, and reconciling bank statements to save time.
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Identify customers with outstanding payments.
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CHAPTERS
00 The Complete Guide to Improving Your Business with Accounts Receivable
01 Accounts Receivables and Assets Explained
02 Accounts Receivable vs. Accounts Payable: What's the Difference?
03 What Is the Accounts Receivable Process?
04 Setting Up an AR Process; Get Paid Faster & Increase Cash Flow
05 Make it Simple to Receive Payments from Your Customers
