What are accounts receivable?
Accounts receivable (AR) are the funds due to a business for services provided, and products sold or used by clients but not yet paid for. These services and products are mostly provided on credit, and any amount owed by clients for purchases may count as accounts receivable.
In short, they are the yet-to-be-paid invoices of a company by a client. Companies extend a line of credit to their customers which needs to be paid back within a short period of time, ranging from a few days up to a fiscal year.
How accounts receivable work
Accounts receivable usually appear as current assets on the business’s balance sheet because they are due to be paid in one year or less. These are quite useful on a number of occasions such as when they need to get an asset-based loan. Accounts receivable are considered liquid assets that can be easily converted to cash and therefore can be used as collateral to borrow money for short-term needs. Accounts receivable can be purchases made on store credit, electricity bills, or subscriptions.
Accounts receivable are different from accounts payable which are debts owed by the company to others, like their suppliers.
The days’ sales outstanding (DSO) measures the average number of days it takes a business to collect its AR balances. It is calculated by dividing the average AR balance by the daily sales. A lower DSO indicates that the business is collecting its AR balances more quickly.
In case a client fails to pay the AR, it is either written off as a bad debt expense or as a one-time charge.