As part of OnlineAdvisor’s efforts to educate, inform and encourage business leaders, we present key financial terms and concepts.  The concept of accounts receivable is an important one for executives, especially those responsible for sales departments.  The reason is simple: customers who do not pay their invoices to the company will eventually lose the opportunity to buy.  Therefore, sales managers and executives must understand accounts receivable to keep relationships and grow sales.

Definition

Accounts receivable refers to the outstanding invoices a company has or the money the company is owed from its clients. The phrase refers to accounts a business has a right to receive because it has delivered a product or service.

These accounts essentially represent lines of credit extended by a company.  They are due within a relatively short time period, ranging from a few days to a year.

The Practical Side

Most companies operate by allowing some portion of their sales to be on credit. Some businesses offer this type of credit to frequent or special customers. The practice allows customers to avoid the hassle of physically making payments as each transaction occurs.

If a company cannot collect what it is owed on an account, it can take the debtor to court over the unpaid debt.  The company can also outsource the debt collection activity to a third-party bill collector.

In other cases, businesses sell their accounts receivable for pennies on the dollar to a factoring company that then collects the debt. Factoring companies often offer some cash up front, making them an attractive option for companies that need a boost to their working capital.

Accounting Matters

If a business has reported an account receivable as income and it does not receive payment, it has a bad debt. The Internal Revenue Service (IRS) allows businesses to subtract bad debts on their income tax returns. This is allowed as long as the debt was part of income on a previous return.

You may be thinking that you will never have to deal with the concept of accounts receivable.  Keep in mind it is more common than you think.  If you receive multiple payments from one customer, expect to deal with accounts receivable on your accounting reports.  Additionally, if you do not receive payment in full right after you generate an invoice, you will have an accounts receivable entry.

This isn’t a scary or a bad thing.  The key point to understand is that you will receive payment in the future.  The goal is for the account to be paid in full.  If you manage your accounts receivable wisely, it will work well for you.