The Effects of Accounts Receivable on a Balance Sheet

by Cam Merritt

Accounts receivable, commonly abbreviated "A/R," represents money owed to a company for products it has supplied or services it has rendered. It's an important entry on a company's balance sheet, because it shows not only how much money the company expects to collect in the near future, but also how much of that company's sales are on credit.

Accounting for Receivables

Under standard corporate accounting rules, a company generally doesn't include a billed amount in accounts receivable on the balance sheet until it has fulfilled its obligation to deliver goods or services. Once the company has fully "earned" the money by carrying out its end of the transaction, it adds the billed amount to accounts receivable. It also records that amount as revenue on its income statement -- even though it has yet to be paid.

Current Asset

Despite the fact that the company doesn't have the money in hand just yet, accounts receivable is included as an asset on the balance sheet. In corporate accounting, an asset is anything with future economic value. Since the company has a reasonable expectation of receiving the money, A/R fits the definition of an asset. Balance sheets classify assets as either "current" and "long-term," based on how long it would take to liquidate them -- that is, convert them to cash. Current assets are those that can be liquidated within a year; A/R is a current asset.

Payment

When a customer pays a bill, the company reduces its accounts receivable by the amount of the payment. Assuming the customer pays in cash, the company then increases its cash account on the balance sheet by the same amount. ("Paying in cash," in this sense, just means paying with money rather than an exchange of goods or services. Even if a customer pays a bill with a credit card, the company still gets cash from the credit-card company.) The company doesn't record any revenue when it collects a receivable -- it did that back when it first sent the bill. It just transfers the proper amount from A/R to cash on the balance sheet.

Uncollectible Allowance

Of course, customers sometimes don't pay their bills -- even when sued or pursued by a collection agency -- so a certain portion of the accounts receivable balance is never going to turn into cash. Recognizing this, companies create a related category on the asset side of the balance sheet, "allowance for uncollectible (or doubtful) accounts." This is an estimate, based on past experience, of how much of A/R can't be collected. The allowance is a contra asset, meaning it's always a negative amount. Subtracting the allowance from A/R gives you a more accurate figure of the true asset value of A/R.

Turnover Ratio

Investors and analysts use a metric called the "receivables turnover ratio" to gauge how efficiently a company is using credit sales. Take the net amount of sales made on credit over a certain period -- that is, all credit sales minus credit returns -- and divide it by the average A/R balance during that period. The lower the number, the more likely it is that the company is slow in collecting its receivables. That can leave the company short of cash. The higher the turnover ratio, the more efficient the company's collections.

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