What Is Accounts Receivable (AR)?

Accounts receivable are the funds that customers owe your company for products or services
that have been invoiced. The total value of all accounts receivable is listed on the balance sheet
as current assets and include invoices that clients owe for items or work performed for them on
credit.

Generally, vendors bill their customers after providing services or products according to terms
mutually agreed on when a contract is signed or a purchase order is issued. Terms typically
range from net 30 — that is, customers agree to pay invoices within 30 days — to net 60 or even
net 90, which a company may choose to accept to secure a contract. However, for large orders,
a company may ask for a deposit up front, especially if the product is made to order. Services
firms also frequently bill some portion of their fees up front.

Once a company delivers goods or services to the client, the AR team invoices the customer and
records the invoiced amount as an account receivable, noting the terms.

If the client pays as agreed, the team records the payment as a deposit; at that point, the
account is no longer receivable. If the customer fails to pay on time, the AR or collections team
will likely send a dunning letter, which may include a copy of the original invoice and list any late
fees.

With accounting and finance software, companies can improve their days payables metrics by
automatically emailing customers about past-due invoices and requesting immediate payment.
Business leaders can drill down into each account, or all past-due accounts, for more detailed
reporting on customer, invoice, due date, amount due and credit terms. Look for the ability to
exclude certain customers, such as those with extended terms, from collection emails.

Accounts Receivable Example

Frames Inc. views StyleVision as a promising customer and is interested in growing the
relationship. To win more business, Frames Inc. offers StyleVision net-60 with a 50%
prepayment on new purchase orders of $1,000 or more. When StyleVision submits an order for
$1,000, Frames Inc., which uses accrual accounting, records the full $1,000 as an asset in
accounts receivable when the order ships, expecting that the full invoice will be paid as agreed
within 60 days after receipt of the frames.

How to Record Accounts Receivable

In accrual accounting, your receivable balance is listed in the general ledger under current
assets. When invoices are paid, finance credits the appropriate liabilities account and debits
accounts receivable to account for the payment. Applicable late fees would also be accounted
for as part of accounts receivable.

Several important ratios rely on accounts receivable, including:

Accounts receivable turnover ratio: Also known as the “receivable turnover” or “debtors
turnover” ratio, the accounts receivable turnover ratio measures how efficiently and quickly a
company converts its account receivables into cash within a given accounting period. The
formula for calculating the AR turnover rate for a one-year period looks like this:

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%20them%20on%20credit.