Accounts Receivable

Accounting Credit and Lending
Money owed to a firm by customers for goods/services already delivered; a key working-capital item tied to trade credit.
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Accounts receivable (AR) are unpaid customer invoices: money a firm expects to collect for goods or services it has already delivered.

Where it fits economically

Accounts receivable are the accounting record of trade credit.

  • For the customer, trade credit is short-term borrowing from the supplier.
  • For the supplier, AR ties up cash and creates credit risk, but can increase sales by making payment terms easier.

Balance-sheet and cash-flow mechanics

  • AR is typically a current asset.
  • When a firm sells on credit, revenue can be recognized before cash is received, so sales growth can raise AR even if cash flow is flat.
  • Firms often record an allowance for expected nonpayment (credit losses), especially when collections are uncertain.

Common performance metrics

Two widely used measures are:

  • Receivables turnover

[ \text{Turnover} = \frac{\text{Credit sales}}{\text{Average AR}} ]

  • Days sales outstanding (DSO)

[ \text{DSO} = \frac{\text{Average AR}}{\text{Credit sales}} \times 365 ]

Higher DSO usually means slower collections and tighter liquidity.

Practical example

A firm sells $1 million per month on net-60 terms. If customers start paying in 90 days instead of 60, AR rises even if sales are unchanged. The firm may need more short-term financing to cover payroll and inputs.

Knowledge Check

### Accounts receivable (AR) are best described as: - [x] Unpaid customer invoices for goods/services already delivered - [ ] Cash the firm has in its bank account - [ ] The firm’s long-term debt obligations - [ ] A government tax liability > **Explanation:** AR records credit sales that have been recognized but not yet collected in cash. ### What does a higher days sales outstanding (DSO) usually indicate? - [x] Slower collections and tighter liquidity - [ ] Faster collections and more cash on hand - [ ] Lower credit risk by definition - [ ] Higher GDP growth by definition > **Explanation:** DSO rises when average receivables are large relative to sales, meaning cash is tied up longer. ### Why might a firm offer trade credit (creating AR) even though it increases risk? - [x] It can raise sales by making payment terms easier for customers - [ ] It eliminates the need to invoice customers - [ ] It guarantees zero bad debts - [ ] It reduces the need for working capital > **Explanation:** Trade credit can be a competitive tool, but it creates credit risk and working-capital needs for the supplier.
Accrual Rate
Accounts Payable