Accounting and bookkeeping
Accounts receivable (AR)
Accounts receivable represents the total amount of money owed to a business by its customers for goods or services that have been delivered but not yet paid for.
What is Accounts receivable?
Accounts receivable is the balance of money due to your business from clients who have purchased your goods or services on credit. When you deliver a product or complete a service but agree to let the customer pay you at a later date, you create a receivable. This balance is recorded as a current asset on your balance sheet because you expect to convert it into cash within one year. Managing this balance properly ensures you have enough cash to cover your own obligations, like rent and payroll. If you allow customers 30 or 60 days to pay, you are essentially extending them a short-term loan. Keeping a close eye on these outstanding invoices helps you identify late payers early, maintain a healthy cash flow, and avoid the risk of bad debts that can harm your overall profitability.
How Accounts receivable works
The accounts receivable process begins the moment you agree to provide goods or services to a customer on credit terms. Once you deliver the order, you issue a sales invoice detailing the amount due and the payment deadline. At this point, your accounting system records the invoice amount as an increase to your accounts receivable balance and recognises the revenue. While you wait for payment, you monitor the outstanding balances using an aging report to track which invoices are current and which are overdue. If a customer misses their deadline, you follow up with payment reminders or statements of account. Finally, when the customer transfers the funds, you apply the payment against the specific invoice, which reduces your accounts receivable balance and increases your cash balance.
- Agree on payment terms with your customer before delivering the goods or services.
- Issue a clear tax invoice immediately after completing the delivery or service.
- Record the outstanding amount as a current asset in your general ledger.
- Monitor unpaid invoices regularly using an accounts receivable aging report.
- Send polite payment reminders or statements to customers as their due dates approach.
- Record the incoming payment to clear the receivable and increase your cash balance.
Worked example
Suppose your company, Gulf Trading LLC, sells office supplies. On 1 March, you deliver goods worth $2,000 to a corporate client with net 30 payment terms. You issue the invoice, and your accounts receivable balance increases by $2,000.
On 15 March, you sell another batch of supplies to a different client for $1,500 on the same terms. Your total accounts receivable balance is now $3,500.
On 28 March, the first client pays their $2,000 invoice in full. You record the receipt, which reduces your accounts receivable balance by $2,000. Your new accounts receivable balance at the end of March is $1,500, representing the second client's unpaid invoice.
Why it matters for your business
Tracking accounts receivable is critical because sales mean nothing until the cash actually reaches your bank account. If outstanding balances grow too large, you may struggle to pay your own suppliers, even if your profit and loss statement shows a healthy profit. Unpaid invoices can quickly choke your working capital. By monitoring who owes you money and when it is due, you can take proactive steps to collect payments on time. Using a system like Paper & Pen, which creates invoices and posts journal entries, helps keep accurate records of these balances. Good receivables management reduces the risk of bad debts and ensures you have the liquidity needed to operate.
Questions
Common questions
Is accounts receivable an asset or a liability?
What is the difference between accounts receivable and accounts payable?
How can I reduce my accounts receivable balance?
Related terms
- Accounts payable Accounts payable is the total amount of short-term debt your business owes to suppliers and vendors for goods or services that you have received but have not yet paid for.
- Aging report An aging report is an accounting document that categorises a company's accounts receivable or payable based on the length of time an invoice has been outstanding.
- Days sales outstanding Days sales outstanding is a financial metric that measures the average number of days it takes a business to collect payment from its customers after a credit sale has been made.
- Bad debt Bad debt is a monetary amount owed to a business that is no longer recoverable because the customer is unable or unwilling to pay their outstanding invoice.
- Working capital Working capital is the financial metric representing the difference between a business's current assets and its current liabilities, indicating its short-term liquidity and operational efficiency.
- Accrual accounting Accrual accounting is a financial method where you record revenue when a sale occurs and expenses when you receive goods or services, regardless of when the actual cash changes hands.