What is Accounts Receivables?
Understanding Accounts Receivables
Most businesses these days have switched to selling on credit to their customers. This allows them to deliver the goods and services the moment the transaction occurs but they get paid a few days or weeks later. They keep a record of these credit payments using an account called “accounts receivable”.
Accounts receivable is the money or cash people owe you for the goods and services they have bought from your business. The customers are required to pay after a decided period and this is stated under the current asset section, for the time being, on the company’s balance sheet. Once the amount is received, it is recorded as revenue only then. This is a part of accruals and matching concept based accounting. The difference between accounts receivable and accounts payable is that the former is an asset account and the latter is a liability account. Accounts payable is the money you owe to other people or businesses.
Explaining accounts receivables
When you’ve been conducting a business, eventually you’ll run into people who do not pay you back the money they owe you. When you’re unable to collect a receivable, it turns into a “bad debt”.
Allowance for uncollectible accounts is an account that helps businesses make an estimate of how much debt they will be unable to collect. When they come up with this estimate, they do it to not overstate the accounts receivables in their financial statements. Let’s take a look at an example. Bad Debts expense would be a separate expense account made. For example your sales are $50,000, and you have noticed that on average, 2% of the receivables annually turn into bad debts. So your bad debts come up to be $50,000 x 2% = $1,000. The entry would be as follows:
Bad Debt Expense DR $1000
Allowance for uncollectible accounts CR $1000
This bad debt expense has to be written off when you’re certain that the clients will not pay. Let’s assume a client, who owes you $300, hasn’t been in touch with you for months and you’re sure he won’t pay. You then make the following entry:
Allowance for uncollectible accounts DR $300
Bad Debt Expense CR $300
If the client does end up paying, you would make the following entry:
Accounts Receivable DR $300
Revenue CR $300
Accounts receivables turnover ratio a ratio that tells us how fast we are collecting the money our receivables owe us. It is calculated by dividing total net sales by average accounts receivable.
Another thing which helps us keep track of our accounts receivables is an accounts receivable aging schedule. This is a schedule which helps tell us which clients are on track to pay within 30 days, which clients are not on track and which clients are really behind on schedule. To make customers pay faster and on time, companies can develop policies and provide them with incentives. And its important to realize when a debt has gone “bad”.
