Accounts Receivable (AR): Definition, Uses, and Examples

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What Is Accounts Receivable (AR)?

Accounts receivable (AR) is an accounting term for money owed to a business for goods or services that it has delivered but not been paid for yet. Accounts receivable is listed on the company's balance sheet as a current asset.

Key Takeaways

• Accounts receivable (AR) is an item on a company's balance sheet that represents money due the company for products or services it has already delivered.
• Accounts receivable is considered an asset to the company.
• The opposite of accounts receivable is accounts payable, which reflects money that a company owes but has not yet paid.

Understanding Accounts Receivable (AR)

Accounts receivable represents money that a business is owed by its clients, often in the form of unpaid invoices. "Receivable" refers to fact that the business has earned the money because it has delivered a product or service but is, at that point in time, still waiting to receive the client's payment.

Accounts receivable, or receivables, can be considered a line of credit extended by a company and normally have terms that require payments be made within a certain period of time. If effect, the company has accepted an IOU from the client. Depending on the agreement between company and client, the payment might be due in anywhere from a few days to 30 days, 60 days, 90 days, or, in some cases, up to a year. At some point along the way, interest on the debt might also begin to accrue.

Companies record accounts receivable as assets on their balance sheets because the customer has a legal obligation to pay the debt and the company has a reasonable expectation of collecting it. They are considered liquid assets because they can be used as collateral to secure a loan to help the company meet its short-term obligations. Receivables are part of a company's working capital.

Furthermore, accounts receivable are classified as current assets, because the account balance is expected from the debtor in one year or less. Other current assets on a company's books might include cash and cash equivalents, inventory, and readily marketable securities.

Assets that could not easily be converted into cash within a year are recorded as noncurrent assets. That category often includes things like physical property, long-term investments, and intellectual property, such as trademarks.

Accounts Receivable vs. Accounts Payable

When a company owes debts to its suppliers or other parties, those are accounts payable. Accounts payable are the opposite of accounts receivable. To illustrate, Company A cleans Company B's carpets and sends a bill for the services.

Company B now owes Company A money, so it lists the invoice in its accounts payable column. While Company A waits to receive the money, it records the amount in its accounts receivable column.

What Accounts Receivable Can Tell You

Accounts receivable are an important element in fundamental analysis, a common method investors use to determine the value of a company and its securities. Because accounts receivable is a current asset, it contributes to a company's liquidity or ability to cover short-term obligations without additional cash flows.

Fundamental analysts often evaluate accounts receivable in the context of turnover, also known as the accounts receivable turnover ratio. It measures the number of times a company has collected its accounts receivable balances during an accounting period and is considered an indicator of both how efficient the company is in collecting its debts and the credit quality of its customers.

Further analysis would include assessing days sales outstanding (DSO), which measures the average number of days that it takes a company to collect payments after a sale has been made.

Example of Accounts Receivable

An everyday example of accounts receivable would be an electric company that bills its clients after the clients receive and consume the electricity. The electric company records an account receivable for unpaid invoices as it waits for its customers to pay their bills.

Most companies operate by allowing a portion of their sales to be on credit. Sometimes, businesses offer such credit to frequent or special customers, who receive periodic invoices rather than having to make payments as each transaction occurs. In other cases, businesses routinely offer all of their clients the ability to pay within some reasonable period after receiving the products or services.

When Does a Debt Become a Receivable?

A receivable is created any time money is owed to a business for services rendered or products provided that have not yet been paid for. For example, when a business buys office supplies, and doesn't pay in advance or on delivery, the money it owes becomes a receivable until it's been received by the seller.

Where Do I Find a Company's Accounts Receivable?

Accounts receivable are recorded on a company's balance sheet. Because they represent funds owed to the company (and that are likely to be received), they are booked as an asset.

How Are Accounts Receivable Different From Accounts Payable?

Accounts receivable represent funds owed to a company and are booked as an asset. Accounts payable, on the other hand, represent funds that a company owes to others and are booked as liabilities.

What Happens If Customers Never Pay What's Due?

When it becomes clear that a receivable won't be paid by the customer, it has to be written off as a bad debt expense or a one-time charge. Companies might also sell this outstanding debt to a third party debt collector for a fraction of the original amount—creating what accountants refer to to as accounts receivable discounted.

What Are Net Receivables?

Net receivables is an accounting term for a company's accounts receivable minus any receivables it has reason to believe it will never collect. It is typically expressed as a percentage of uncollectible debts relative to collectible ones, and the lower the percentage, the better.

The Bottom Line

Accounts receivable is one of the most important line items on a company's balance sheet. It reflects the money owed to a company from the sale of its goods or services that remains to be paid by the buyer. Even though it is not yet in hand, it is considered an asset because the company expects to receive it in due course. The shorter the period of time a company has accounts receivable balances, the better, as it means the company can use that money for other business purposes.