What is Accounts Receivable? | Definition, Working, Pros vs 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 sometimes, the customer takes a little time to pay the due amount for convenience.

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

Key Takeaways

1. Accounts receivable refer to the outstanding payments due to a company for goods or services it has sold on credit to its customers.
2. Accounts receivable are recorded as assets on a company’s balance sheet and are an important indicator of its financial health.
3. Proper accounts receivable management is crucial for a company’s cash flow and profitability.

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 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 they must 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 utility companies’ due bill is considered “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 must be reliable and have the financial strength to repay the amount shortly. With this accounting system, most companies support their valuable customers for long-term business relationships.

Advantages of Accounts Receivable

Accounts Receivable is a due amount that the company will receive shortly. It is a type of credit the company offers 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 customer’s purchasing power increases substantially. In return, they purchase more products from the company, and the business can sell more products to its customers.

Disadvantages of Accounts Receivable

Even though accounts receivable gives multiple benefits to the business, there are some drawbacks associated with it. The first problem of accounts receivable is it puts 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 the money returned. The company may get entangled in a legal battle with the customer on accounts receivable. So, fewer accounts receivable on the balance sheet are 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

Last Updated : 11 June, 2023