Is Accounts Receivable An Asset?: Understanding Basics of Accounting

Accounts receivable are a crucial accounting element for all kinds of businesses, whether they are manufacturing-based or service-based. These deliver payment flexibility to customers, which allows them to buy now and pay later. Businesses record these amounts in their books of accounts as accounts receivable. 

But what confuses beginners is the treatment of accounts receivable. People are confused: is accounts receivable an asset, liability, or revenue? Therefore, we have come up with this write-up to help you understand the treatment of accounts receivable, roles in businesses, and metrics for measuring their performance. 

What is Accounts Receivable? 

Accounts receivable is the amount of money customers owe to a business for their rendered products and services. In simple words, accounts receivable is the amount of goods and services a company serves to its customers on credit. This credit money is considered to be returned within 12 months. 

Accounts receivable are made from the following components:

• Bills Receivable: This is the amount of invoices that have not reached their due dates and are outstanding. If the seller needs this money urgently, they can contact banks to receive the amount before the due date while charging a small percentage of the amount. 
• Debts: This is the amount of invoices that are unpaid even after the due dates. 

Accounts receivable is a crucial element of a business as it determines liquidity and cash flow within a short time. This helps the investors analyze the financial stability of a company. This amount evaluates how effectively a business manages its cash flow, affecting both overall cash flow and cash flow from operating activities. But the ultimate question is, is accounts receivable an asset or not?

Are Accounts Receivable an Asset?

After actively analyzing the nature of accounts receivable, we have unveiled the truth on “Is accounts receivable an asset”?. Accounts receivable are assets, as these produce positive economic value to businesses. Therefore, accounts receivable are recorded on the balance sheet’s asset side. 

It is recorded under the subhead current asset, not a non-current asset, as these can be used, converted, or sold by a business within a year. Non-current assets comprise all the assets that produce economic value for a longer period, such as fixed assets, long-term investments, and intangible assets. 

Role of Accounts Receivable in Businesses

Accounts receivable play a crucial role in business. Here in this section, we have mentioned all areas where accounts receivable benefit businesses. 

• Invoice Management: Accounts receivable assist businesses to effectively manage their receivable invoices. The department of accounts receivable is mainly responsible for sending statements, collecting payments, and managing debtors’ accounts.

• Relationship with Customers: Proactively and effectively managing accounts receivable can help businesses build strong and positive relationships with their customers. This includes timely reaching out to customers for due-date payments. 

• Cash Flow Management: Accounts receivable helps businesses successfully manage their cash inflow and outflow by actively tracking the due dates of all invoices. 

• Minimizing losses: Promptly managing accounts receivable can help a business reduce its potential losses, mainly bad debts. This includes actively analyzing the behavior of the debtor and reaching out before they get insolvent. 

• Decision-Making: The data on accounts receivable can be used to make financial decisions and improvements in business performance. 

Treatment of Accounts Receivable in Balance Sheet

As per the accrual accounting principle, accounts receivable are considered assets, not revenue, since you only record revenue when it is received. The following are the treatments of accounts receivable: 

• Balance Sheet: Accounts receivable are recorded on the asset side of the balance sheet, under the head current assets. 

• Journal: When selling goods and services on credit, the accounts receivable amount is debited, and the sales account is credited. Cash debited and accounts receivable are credited when the due amount is received. 

• Subsidiary Ledger: The transactions appear on both sides of the account receivable subsidiary account. All the journal entries of accounts receivable are recorded on the opposite side with the corresponding account of journal entry.

Metrics for Measuring the Performance of Accounts Receivable

The following are the metrics to measure the performance of accounts receivable:

• AR Turnover Ratio: Opposite to the AP turnover ratio, the AR turnover ratio is one of the most used metrics to measure the KPI of accounts receivable. It shows how timely a business collects money from its debtors. A higher ratio means your company is collecting the money, whereas a low ratio shows that you delayed your money collection. 

• Bad Debts to Sales Ratio: This refers to the amount of debtors that have become insolvent and are now unable to repay the money. These are unrecoverable and considered losses to business. By dividing bad debt by sales, businesses can compute the percentage of total sales that are irrecoverable. A higher percentage means that a company is bearing heavy losses on accounts receivable. 

• Days Sales Outstanding: It is another widely used metric to measure the performance of accounts receivable. It computes the average number of days a business takes to convert its credit sales into cash. A lower DSO shows that a business is easily and quickly recovering money, whereas a high number, or over 60 days, means a business is delaying the collection process. 

• Collection Effectiveness Index: This is a percentage of recovered accounts receivable to the total amount of accounts receivable. It showcases how effective a business is in recollecting its receivables. A high CEI shows that your business has recovered a large portion of accounts receivable.

• Number of Revised Invoices: It is a crucial KPI of business that depicts how correctly a business processes its invoices. A higher number means your business is not processing invoices effectively, which can lead to delays in recovering receivables. 

• Average Days Delinquent (ADD): Also known as delinquent days sales, average days delinquent indicates the number of days an invoice has passed its due dates. A higher ADD shows that your customers delay payments, whereas a low ADD means you get paid quickly.

• Average Collection Days: This refers to the average number of days your business takes to recollect money from debtors after selling your products or services. According to this metric, having a low ACS is better, meaning that you generally collect your money within a few days. 

• Expected Cash Collection: This refers to the amount of money expected by the business to recover in a given time. It consists of cash sales as well as collectible amounts from the debtors. The performance of your accounts receivable department is considered low if the actually collected receivables are less than the collectible amount. 

For further assistance in accounts receivable, you can also reach out to professional accounts receivable services. These help you effectively generate invoices, manage customer accounts, collect payments, and much more. 

Wrapping Up

Accounts receivable are a crucial element of businesses. They allow customers to make credit purchases of goods and services that need to be timely repaid. Due to being recorded on the asset side of the balance sheet, these are considered assets to the business. Opting for metrics like AR turnover ratio, bad debts to sales ratio, and days sales outstanding can effectively measure the performance of your accounts receivable.