Accounts receivable explained

Accounts receivable is money owed to you by your customers for merchandise purchased. It is a current asset reported on your balance sheet.

Understanding accounts receivable

Suppose you are a wholesaler who ships merchandise in truckloads to your customers.  You ship goods to customers’ loading docks, where workers can unload the trucks.  Here’s the problem: those workers usually can’t pay you for the merchandise.  They are truck-unloaders, not check-writers-and-signers.  Therefore, you have no choice but to extend credit to your customers, and wait until the paperwork makes all the way to your customer’s check-writers-and-signer, who mail you the check.
Furthermore, because your competitors extend credit to your customers, you, too, may be forced to do the same.  Putting a customer on “C.O.D.” (“Cash on Delivery”) is often like telling that customer to get lost.
Accounts receivable terms are typically described like this: 2/10 net/30.  This means that the customer is entitled to a 2% discount if they pay within 10 days, and the full balance is due within 30 days.

Typical journal entries

To record a $1,000 sale made on credit, debit the accounts receivable account and credit sales revenue:
 JE Sale on credit
When you collect $900 of the sale, debit the cash account and credit accounts receivable.
JE Collection of accounts receivable

Bad debts

A major in accounts receivables is collectibility. Unfortunately, customers sometimes fail to pay back their debts. This means that a small percentage of accounts receivables are deemed to be uncollectible or “bad debts.” Accounts receivable is reported as a current asset “net” of bad debts. This means that companies report the actual amount of accounts receivable that they expect to collect, rather than the total balance owed to them.

Managing receivables

For many businesses, receivables are a necessary evil.  They need to extend enough credit to keep their customers happy and to sustain their sales.  However, they should avoid lending to credit-unworthy customers, and try to collect accounts receivable as quickly as possible.

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