Tax & admin 23 June 2017

What is accounts receivable and why is it important?

balance_sheet
It’s important to keep a track of who owes you money

Understanding the different aspects of a balance sheet is important to the success of any business. Writing for Business Advice, Ormsby Street’s Rob Drury explains what is accounts receivable and why it’s an important value to your venture.

If you’re the business owner, you spend a large proportion of your time trying to work out where your next customer is going to come from. Where can you find someone to give you money for the goods and services you offer?

For some of those customers you might have offered them credit in order to get the deal, so you’ve delivered goods or provided a service and at some point in the future they will hand over some money in return. How is this accounted for in your books, and what if they don’t?

What is accounts receivable (AR)?

Put simply, accounts receivables are the sales that you’ve made and delivered, but which haven’t been paid for yet. They’re a record of the fact that you’ve done some work for customer X and that customer X owes you a certain amount of money.

Obviously it’s important to keep a track of who owes you money because these debts need to be paid.  For every business that offers some form of credit (payment after receipt of goods or service, for example) they will have some level of accounts receivables – a list of outstanding invoices for which someone has not yet paid you.

This varies from accounts payable, which are a list of outstanding invoices that you or your business has not yet paid to other people.

Why is accounts receivable important?

The money you used to create the goods or deliver the service has likely disappeared out of your business, as you’ve paid your supplier or your staff, and if you sell a product then that inventory has also already disappeared off your books, so you need an asset in your business to balance this out, and that’s why your accounts receivables appear in the assets line of your balance sheet.

These accounts receivable are then things that require action on your part to turn the debt into cash. Many customers will pay their debts within the expected amount of time, but it’s been  calculated that the average time it takes a small business owner in the UK to get paid is 71 days.

That’s 71 days between an invoice being issued and the payment being received.  A time during which these invoices are classed as accounts receivable, and a time during which the business needs to somehow fund their operations without the cash from these invoices.  It’s no surprise that cash flow is such a major issue for small businesses.

Is accounts receivable a good thing or not?

On the surface, accounts receivable are a good thing in that it does show that the business has successfully obtained orders and delivered on those orders, and it indicates that funds will be coming in to the business.

This is why when people ask what are accounts receivable, most accountants would generally agree they’re an asset, to be considered by lenders and investors as valuable to the business.

As they’re an asset they can be used by the business to obtain funding, through the likes of invoice financing, where a third party will effectively buy the accounts receivable in exchange for a percentage of their value.  This can bring guaranteed funds into the business at a time when it might needed, rather than the business having to wait until it eventually receives payment.

However, a business needs to ensure that it is converting its accounts receivables into cash and  getting paid, or else they’ll see all the cash going out of the business to pay bills, rent, and wages, and no real funds coming into the business, as it stays in paper form as accounts receivables.

Too much of what is accounts receivable on balance sheets could lead to cash flow issues for your business, and addressing this concern can be done even before a customer is signed up through appropriate levels of due diligence.

That’s why many businesses have individuals whose role it is to assess the creditworthiness of potential customers and ensure that what is accounts receivable will get paid as soon as possible.

In our small business products, we provide data to our 40,000 customers on how promptly a business will likely pay its bills. The longer the time they pay then the longer an invoice will sit in accounts receivable instead of turning into the cash that the business needs to survive.

The economist, John Maynard Keynes, said:  “If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has”. The same applies to what is accounts receivable – if your customer owes you a hundred pounds they have a problem, but if they owe you a million then it’s your problem.

Robert Drury is head of product at small business cash flow platform Ormsby Street

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