What is Accounts Receivable? | Definition, Working, Pros and Cons

In this modern age, every business does financial transactions with their customers. In most cases, the customer pays the due amount at the time of the transaction. But in some cases, the customer takes a little time to pay the due amount for their convenience.

Accounts receivable are due balance money that company hasn’t received yet against their goods or services. According to accounting methodology, this amount is considered as income. All account managers put this amount on the balance sheet as a current asset. Let’s learn how do account receivables work and what are the advantages & disadvantages associated with it.

How does it work?

The business environment is very competitive nowadays. For this reason, every business is trying to give extra support to their customers to increase their consumer base. As a result, many businesses offer a line of credit to their customer where the customer can pay back the due amount in the recent future. In the accounting world, it is called “Accounts Receivable”. It is a business phrase that refers to an unpaid invoice by the customer.

For a customer, it is like a debt that they have to pay within a certain time frame. In the accounting books, it is only justified against any sales of goods or services. As a result, the due amount is considered an asset. For example, the due bill of the utility companies is considered as “Accounts Receivable”. Here the customers utilize water and gas from the utility company and pay the bill later.

Unlike utility companies, most companies do not offer this credit to all customers. The customer has to be reliable and must have the financial strength to repay the amount in near future. With this accounting system, most companies support their valuable customers for a long-term business relationship.

Advantages of Accounts Receivable

Accounts Receivable is a due amount that the company will receive in near future. It is a type of credit the company offering to its customer. As a result, it improves the customer and company relationship. It strengthens long-term business relations with the customer.

In the long run, it becomes a competitive advantage for the business. With more credit from the company, the purchasing power of the customer increases substantially. In return, they purchase more products from the company, and the business able to sell more products to their customers.

Disadvantages of Accounts Receivable

Even though accounts receivable gives multiple benefits to the business, but there are some drawbacks associated with it. The first problem of accounts receivable is it put a strain on companies cash reserve, which can reduce its growth rate. Most companies with large accounts receivable spend less on different projects.

There is also bad debt risk associated with accounts receivable. For this reason, the company has to constantly follow-up with the customer to get returned the money back. In some cases, the company may get entangled in a legal battle with the customer on accounts receivable. So, fewer accounts receivable on the balance sheet is always better.

Resources

  1. https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.1992.tb03982.x
  2. https://www.sciencedirect.com/science/article/pii/S0148619598000083
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