Account Receivable: Meaning, Process and Examples

Account Receivable: Meaning, Process and Examples

9 mins readComment
Chanchal Aggarwal
Senior Executive Content
Updated on Dec 20, 2023 18:04 IST

Accounts receivable (AR) represent the money owed to a business by its customers for goods or services delivered but not yet paid for. As a crucial component of a company's current assets, AR is essential for cash flow management and indicates the financial health and liquidity of the business.

Imagine a local bookstore in Mumbai selling a bulk order of textbooks to a school on credit. The school agrees to pay within 30 days. This transaction is recorded as an account receivable for the bookstore. Accounts receivable represent such money owed to a business for goods or services delivered but not yet paid for. It's a crucial part of a company's finances, listed as a current asset on the balance sheet, indicating expected cash inflow and playing a key role in managing cash flow. Let’s understand what is Account Receivable and other related concepts. 

Table of Content

Account Receivable Meaning

Accounts receivable, often abbreviated as AR, is the term used when a company has sold goods or services but hasn't yet received payment. It's like an IOU from customers. When a business allows a customer to pay later, this amount is recorded as an account receivable, essentially a claim for money owed. These receivables are considered assets on the company's balance sheet because they represent funds that the business expects to receive in the near future.

Account Receivable Process

Credit Approval: Before offering credit to a customer, a company may assess the customer's creditworthiness. This involves evaluating their financial history and ability to pay.

Example: A textile manufacturer in Surat decides to sell fabrics to a new clothing retailer. Before extending credit, they check the retailer's credit history and financial statements to assess their ability to pay.

Sales and Invoicing: Once a sale is made, an invoice is generated and sent to the customer. This invoice details the products or services provided, the amount due, and the payment terms (e.g., due in 30 days).

Example: After the sale, the manufacturer sends an invoice to the retailer, detailing the quantity of fabric, the total cost, and payment terms, such as "Net 30" (payment due within 30 days).

Recording the Sale: The sale and corresponding amount owed by the customer are recorded in the accounts receivable ledger. This entry increases the company's accounts receivable (an asset on the balance sheet).

Example: The manufacturer records this transaction in their accounts receivable ledger, noting the retailer's name, invoice amount, and payment due date. This increases their accounts receivable balance.

Payment Tracking and Reminders: The company monitors the receivables ledger to track due dates and sends reminders or statements to customers as their payment due dates approach.

Example: As the payment due date approaches, the manufacturer monitors the ledger. If payment isn’t received, they send a reminder email to the retailer.

Receiving Payment: When a customer pays their invoice, the payment is recorded, and the corresponding amount is deducted from the accounts receivable balance. The cash or bank balance of the company is also updated to reflect the receipt.

Example: The retailer makes the payment via bank transfer. The manufacturer records this payment, reducing the accounts receivable balance and increasing their bank balance.

Reconciliation: Regular reconciliation is important to ensure that payments are accurately recorded and that the accounts receivable ledger reflects the true amount owed by customers.

Example: The manufacturer regularly reconciles their bank statements with the accounts receivable ledger to ensure all payments are accurately recorded.

Handling Overdue Accounts: For overdue payments, the company may send additional reminders, make phone calls, or, in some cases, resort to collection agencies or legal action.

Example: If the retailer fails to pay on time, the manufacturer sends additional reminders. If the payment is significantly delayed, they may consider calling the retailer or taking legal action.

Bad Debt Management: If it becomes clear that a receivable will not be collected, it may be written off as bad debt, which is an expense for the company.

Example: After several attempts to collect the payment fail, the manufacturer may decide to write off the amount as bad debt, acknowledging that it's unlikely to be recovered.

Reporting: Regular reports are generated to provide insights into the status of accounts receivable, such as aging reports that categorize receivables based on how long they have been outstanding.

Example: The manufacturer generates monthly accounts receivable reports, categorizing receivables by age (e.g., 30 days, 60 days) to identify patterns and potential issues.

Policy Review and Adjustment: Based on the performance of the AR process, policies may be reviewed and adjusted for better management in the future, such as changing credit terms or improving collection strategies.

Example: Based on their experience, the manufacturer might decide to tighten their credit policy, perhaps requiring advance payment from new customers or those with a poor payment history.

Benefits of Accounts Receivable

Improved Cash Flow Management: Efficient AR management ensures a more predictable and consistent cash inflow. By reducing the time between sales and receiving payments, businesses can maintain better cash flow, which is essential for covering operational costs, paying employees, and investing in business growth.

Decreased Credit Risk: Properly managing AR involves assessing the creditworthiness of customers before extending credit. This practice helps in minimizing the risk of non-payment and bad debts, which can significantly impact a company's financial health. Regular follow-ups and clear credit policies reduce the likelihood of unpaid invoices.

Enhanced Customer Relationships: Effective AR management includes clear communication about payment terms and expectations. This clarity helps in building trust and transparency with customers, leading to stronger business relationships. It also allows for more personalized customer service, as you can address specific payment concerns or issues.

Valuable Financial Insights: AR data provides critical insights into the financial health and performance of a business. Analyzing this data can reveal trends in customer payment behaviors, sales effectiveness, and market demand. These insights are invaluable for strategic planning, budgeting, and forecasting.

Operational Efficiency: Implementing streamlined AR processes, such as automated invoicing, electronic payments, and efficient tracking systems, reduces the administrative burden and time spent on managing receivables. This efficiency can free up resources to focus on other areas of the business.

Accurate Financial Reporting: Reliable and up-to-date AR records are essential for accurate financial reporting. They ensure that financial statements accurately reflect the company's financial position, which is crucial for internal decision-making and external reporting to stakeholders.

Access to Financing Options: A strong AR ledger can be an asset when seeking external financing. Businesses can use their accounts receivable as collateral for various financing options, such as factoring or invoice discounting. This can provide an additional source of capital, especially for businesses that might not have other forms of collateral.

Competitive Edge: Offering credit terms can be a competitive advantage in markets where such options are limited. It can attract and retain customers who prefer or require the flexibility of buying on credit, potentially leading to increased sales and market share.

Risk Mitigation: Regular monitoring and management of AR can help in the early identification of potential risks, such as customers consistently paying late or an increasing number of disputed invoices. Early detection allows for timely intervention to mitigate these risks.

Regulatory Compliance: Effective AR management ensures compliance with accounting standards and financial regulations. This is particularly important for public companies or those seeking to attract investors, as it demonstrates sound financial practices.

Impact of AR on Cash Flow and Financial Modeling

Cash Flow Impact:

Timing of Cash Inflows: AR represents future cash inflows from credit sales. The timing of these inflows is crucial for cash flow management. Delays in collecting receivables can lead to cash flow shortages, affecting the company's ability to pay its obligations on time.

Liquidity: High levels of AR can tie up a significant portion of a company's funds, impacting liquidity. Efficient AR management ensures that cash is available for operational needs, investments, and debt servicing.

Credit Management: The terms and conditions of credit sales (like payment period, discounts for early payment, etc.) directly influence the cash flow. More lenient credit terms can potentially slow down cash inflows.

Financial Modeling and Analysis:

Working Capital Management: AR is a key component of working capital. Financial models need to accurately forecast AR to determine the working capital requirements and ensure the business has enough cash to operate effectively.

Revenue Forecasting: AR trends can inform revenue forecasting. Patterns in payment collection can help predict future cash flows, which is vital for budgeting and financial planning.

Risk Assessment: Financial models often include risk assessments related to AR, such as the likelihood of late payments or defaults. This helps in understanding the potential impact on cash flow and making provisions for bad debts.

Valuation and Performance Metrics: AR affects key financial metrics like the cash conversion cycle, return on assets, and overall company valuation. It's important to model these impacts accurately to assess the financial health and performance of the business.

Scenario Analysis: Financial models may use AR data to run different scenarios, such as the impact of changing credit policies or economic downturns on cash flow. This helps in strategic planning and risk management.

Impact on Financial Statements:

Balance Sheet: AR is an asset on the balance sheet. Changes in AR levels can significantly affect the asset side of the balance sheet, impacting financial ratios like current ratio and quick ratio.

Income Statement: While AR is recorded as revenue on the income statement when the sale is made (accrual accounting), the actual cash flow occurs later. This can create discrepancies between reported profits and cash flow.


Accounts receivable is a vital component of a company's financial health, representing the credit sales awaiting payment. Efficient management of AR is crucial for ensuring a steady cash flow, maintaining liquidity, and supporting operational needs. It requires careful monitoring and strategic policies to balance customer relationships with financial stability. Ultimately, effective AR management is key to a business's ability to grow and thrive in a competitive marketplace.

Top FAQs on Account Receivables

What are accounts receivable?

Accounts receivable (AR) are the funds that a company is due to receive from its customers for goods or services provided on credit. They are recorded as an asset on the company's balance sheet.

 Why are accounts receivable important for a business?

AR is important because it represents the cash that a business is expected to receive, which is crucial for maintaining cash flow, meeting operational expenses, and planning for future investments.

 How do companies manage accounts receivable?

Companies manage AR by setting credit policies, issuing invoices, tracking payments, following up on overdue accounts, and using accounting software to maintain accurate records.

 What is an accounts receivable aging report?

An accounts receivable aging report is a financial document that categorizes a company's receivables based on the length of time an invoice has been outstanding, helping to identify potential collection issues.

How does accounts receivable affect cash flow?

AR affects cash flow by representing the future cash inflows from credit sales. Efficient management of AR ensures a steady cash flow, while poor management can lead to cash shortages.

About the Author
Chanchal Aggarwal
Senior Executive Content

Chanchal is a creative and enthusiastic content creator who enjoys writing research-driven, audience-specific and engaging content. Her curiosity for learning and exploring makes her a suitable writer for a variety ... Read Full Bio