Meta Description: Learn everything about accounts receivable (AR)—definition, process, examples, importance, accounting treatment, and best practices for efficient receivables management.
Introduction
Accounts receivable (AR) is a cornerstone concept in accounting that reflects the money owed to a company by its customers for goods or services delivered on credit. Efficient management of receivables can significantly impact a business’s liquidity, financial stability, and operational efficiency.
In this guide, we’ll explore the fundamentals of accounts receivable, supported by examples, best practices, and references from authoritative sources, including accounting textbooks and professional bodies.
What is Accounts Receivable?
Accounts receivable is classified as a current asset on a company’s balance sheet. It represents outstanding invoices or amounts a business expects to collect within a short time period, typically 30 to 90 days.
According to the Generally Accepted Accounting Principles (GAAP), under the accrual accounting method, revenue is recognized when earned, not when cash is received — this gives rise to AR.
📘 Reference: Kieso, D., Weygandt, J., & Warfield, T. (2022). Intermediate Accounting (17th ed.). Wiley.
Real-World Example of Accounts Receivable
Suppose ABC Electronics sells $10,000 worth of laptops to a corporate client on net 30 credit terms. ABC records:
Date: Jan 1
Debit: Accounts Receivable $10,000
Credit: Sales Revenue $10,000
When the client pays on Jan 30:
Date: Jan 30
Debit: Cash $10,000
Credit: Accounts Receivable $10,000
This reflects both the revenue recognition and the settlement of AR.
Why Accounts Receivable is Important
- Cash Flow Management: Efficient collection ensures liquidity.
- Customer Relationship: Offering credit builds trust and may increase sales.
- Performance Metrics: Metrics like Days Sales Outstanding (DSO) help track collection efficiency.
🔍 Tip: A rising AR balance without corresponding cash inflows may signal deteriorating collection practices or credit risk.
Accounts Receivable vs. Accounts Payable
| Feature | Accounts Receivable (AR) | Accounts Payable (AP) |
| Nature | Asset (inflow expected) | Liability (outflow expected) |
| Related to | Credit sales | Credit purchases |
| Recorded when | Goods/services sold on credit | Goods/services bought on credit |
| Balance Sheet Position | Current Assets | Current Liabilities |
Managing Accounts Receivable: Best Practices
1. Credit Policy Design
Establish clear terms: e.g., net 30, early payment discounts (2/10, net 30).
Example: A 2/10 net 30 term means a 2% discount if paid within 10 days.
2. Invoice Promptly and Accurately
Use invoicing software like QuickBooks, Xero, or FreshBooks to generate and send invoices immediately after service.
3. Maintain an Aging Schedule
An Aging Report breaks down AR by the number of days outstanding:
| Age of AR | Amount |
| 0–30 days | $20,000 |
| 31–60 days | $5,000 |
| 61–90 days | $2,000 |
| 90+ days | $1,000 |
Helps prioritize collections and assess bad debt risk.
4. Automate Reminders and Follow-Ups
Use automation tools like Zoho Books, Chargebee, or Bill.com for reminders.
5. Provision for Doubtful Debts
In line with the conservatism principle, businesses estimate and record uncollectible amounts via the Allowance for Doubtful Accounts.
Journal Entry:
Debit: Bad Debt Expense
Credit: Allowance for Doubtful Accounts
📘 Re ference: Horngren, C., Sundem, G., & Elliott, J. (2021). Introduction to Financial Accounting (12th ed.). Pearson.
Key Metrics to Monitor
1. Days Sales Outstanding (DSO)
DSO=(Average Accounts Receivable / Net Credit Sales) * Number of Days in the Period
Lower DSO = faster collections.
2. Receivables Turnover Ratio
Receivables Turnover=Net Credit Sales / Average Accounts Receivable
Higher ratio = efficient AR management.
Common Challenges in AR Management
Late Payments: Affects cash flow.
- Bad Debts: Write-offs impact net income.
- High DSO: Indicates inefficiency or lax credit policies.
- Poor Documentation: Leads to disputes or delayed payments.
Technological Solutions
Cloud-based AR platforms help automate workflows, improve visibility, and integrate with CRMs and ERPs:
- QuickBooks Online AR Automation
- Oracle NetSuite
- SAP S/4HANA
- Zoho Books
- Bill.com
Industry Benchmarks for AR
| Industry | Average DSO (days) |
| Manufacturing | 45–60 |
| Retail | 15–30 |
| SaaS / Software | 35–55 |
| Construction | 60–90 |
(Source: Sage Intacct AR Metrics 2024)
Accounting for Bad Debts: Direct Write-Off vs. Allowance Method
1. Direct Write-Off Method (Not GAAP compliant for most businesses):
Debit: Bad Debt Expense
Credit: Accounts Receivable
2. Allowance Method (GAAP-compliant):
Estimates future uncollectibles, impacting net AR.
Debit: Bad Debt Expense
Credit: Allowance for Doubtful Accounts
When an actual write-off occurs:
Debit: Allowance for Doubtful Accounts
Credit: Accounts Receivable
Tax Implications
Bad debts can be deducted under IRS rules for accrual-based taxpayers. Specific documentation is required for write-offs.
📝 IRS Reference: Publication 535 – Business Expenses
Summary
Accounts receivable is more than a number on the balance sheet — it is a vital tool for managing cash flow, supporting sales growth, and ensuring financial transparency. Proper AR management requires a mix of accounting knowledge, operational discipline, and the right technology.
References
- Kieso, D., Weygandt, J., & Warfield, T. (2022). Intermediate Accounting. Wiley.
- Horngren, C., Sundem, G., & Elliott, J. (2021). Introduction to Financial Accounting. Pearson.
- Sage Intacct AR Benchmarks
- IRS Publication 535 – Business Expenses
- Investopedia: Accounts Receivable
Final Thoughts
Whether you’re a student learning the basics or a business owner seeking financial efficiency, understanding accounts receivable is crucial. It offers insights into customer credit behavior, highlights operational performance, and can unlock working capital when managed properly.