Accounts receivable (AR)
The money customers owe a business for goods or services it has already delivered and invoiced.
In short
- AR is a current asset: cash the business expects to collect, usually within weeks.
- It is also the team and process that invoice customers, apply payments and follow up on overdue accounts.
- Revenue is not cash. A business can be profitable on paper and short of cash because of slow receivables.
Accounts receivable, or AR, is what customers owe after buying on credit. When a business delivers goods or services and sends an invoice with payment terms, the amount becomes a receivable until the customer pays. On the balance sheet it sits under current assets.
The AR process
- An invoice is issued, with terms such as net 30.
- The customer pays, by transfer, card, cheque or direct debit.
- The payment is applied to the right invoice, which is called cash application.
- Overdue invoices are followed up with reminders, calls and sometimes collection action.
- Invoices that will not be paid are written off as bad debts.
Why it matters
Receivables tie up cash. A business that sells $1 million a month on 60-day terms has about $2 million owed to it at any moment, money it has earned but cannot spend. Collecting faster, even by a week, frees up working capital without selling anything more.
Receivables also carry risk. The longer an invoice stays unpaid, the less likely it is to be collected. That is why finance teams watch the aging report and days sales outstanding, and why credit limits are set before a customer is allowed to build up a large balance.
Worked example
Profitable but short of cash
A staffing agency invoices $300,000 a month on net 45 terms, but clients pay in 70 days on average. At any time, about $700,000 is owed to it, while its workers are paid every two weeks. Even with healthy margins, it needs a line of credit to bridge the gap until receivables come in.