Accounts receivable (A/R) is an accounting term that represents money a company is owed by its customers for goods or services provided. In other words, when a customer has received your product or service on credit, the money they owe is noted as accounts receivable on a budget sheet.
It’s this state of affairs that makes it hard to know whether accounts receivable is an asset or a liability. As a friendly reminder, here are the definitions of assets and liabilities:
- Assets: Anything a company owns that will bring in future economic benefits.
- Liabilities: Anything that costs money to the company and is paid over time.
A/R is money that is owed to a company, which may make it sound like a liability, but that money should eventually land in the company’s bank account, which makes it sound like an asset. To untangle this knot, let’s delve into the classification of accounts receivable and how you can maximize your A/R process.
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Is accounts receivable a liability?
No, accounts receivable is not a liability. A/R is money you’re contractually owed and is reflected as such on a balance sheet. However, it includes the risk of reduced payments or no payment at all.
That uncertainty does have a theoretical price tag, as a large number of outstanding accounts can certainly negatively impact business operations, reducing liquidity and financial flexibility and reducing a business’ capacity for maximizing revenue opportunities. Nevertheless, A/R on the whole is not considered a liability.
Is accounts receivable an asset?
Yes, accounts receivable is recorded as an asset on your balance sheet. Remember, assets are anything that offers a company economic rewards — and since the assumption is that you will be paid the money owed in A/R, accounts receivable is an asset. Other examples of assets include a company’s cash, property, and inventory.
Creates financial gain
Must be paid to suppliers, banks, and other third parties
Owned / Possessed
Owed / Expensed
Are both tangible (cash, property) and intangible (brand value)
Are always tangible
In most cases, accounts receivable is a current asset. If it takes more than a year to receive the money you are owed, it’s a long-term asset.
Accounts receivable is also sometimes referred to as Net Realizable Value (NRV), the cash amount a company expects to receive.
Why is accounts receivable an asset?
Accounts receivable count as an asset because the amount owed to the company should be converted to cash later. The money can then be used to pay expenses or purchase more inventory. It can also be reinvested back into the business.
For example, if a customer orders $5,000 worth of product on credit, that is money that (theoretically, eventually) will be in your company’s bank account, even if it isn’t there right now. To put it another way, a transaction has been made in your favor and there’s no reason to believe payment won’t be received — particularly if you trust your vendors and customers.
As an asset, businesses can borrow against their accounts receivable when they need more liquidity. Have a lean month, but a fairly robust A/R line? Banks will offer loans based on that, at a reasonable rate.
Is accounts receivable revenue?
It’s easy to assume that accounts receivable are revenue, but unless an account is settled, the money owed in accounts receivable is not revenue. Revenue is money that a company has earned through the sale of goods or services while accounts receivable is money owed to a company by its customers. Accounts receivable becomes revenue only when payment has been received
How to maximize the value of accounts receivable.
The best way to get the most out of your A/R is to actually turn it into revenue. This is vital for any business. Cash flow keeps everything moving, be it product development, hiring, or capital improvements. Not having a regular cash flow transforms your A/R line from an asset into a liability.
The best way to avoid this is to have an automated collections strategy. Having structured responses for accounts that are 30, 60, and 90 days late will increase payments for existing orders and future transactions.
Your basic collections strategy should include:
- Automation: Create templates and schedules to communicate with your customers
- Plainly articulate payment terms: Spell out to your customers when payment is due
- Consider early payment discounts: Provide an incentive for customers who pay promptly
- Offer payment plans: Be willing to work with customers who may have difficulty paying
- Make it easy: Give customers a variety of payment options and provide them with a portal to pay at their convenience
You may also consider turning your business’s Accounts Receivable Turnover (ART) ratio into a North Star metric. ART measures the number of times a year a business collects its average accounts receivables. It looks at how effectively you can provide credit and collect payments promptly.
Accounts receivable turnover formula:
Net Annual Credit Scores ÷ (Starting Accounts Receivable + Ending Accounts Receivable) / 2)
Whatever your business ultimately considers A/R, it’s important to have a strategy that will effectively highlight it as an asset or reduce the impact as a liability. Using a comprehensive, accounts receivable automation platform will help you maximize the former and minimize the latter.
Automate the accounts receivable process with Invoiced
One of the easiest ways to get paid faster and avoid accounts receivable turning into bad debt is to automate your accounts receivable process.
Learn more about how Invoiced can make A/R management easier by scheduling a demo today.