accounts receivable Cash Flow Cash management
5 mins read

What are accounts receivable and why are they important?

What does accounts receivable mean?  

The accounts receivable definition is the money owed to your company by customers for the goods or services you’ve provided, but for which they are yet to pay. It’s important to note that accounts receivable is also referred to using the term ‘trade receivables’. If someone asks you about your trade receivables, they are asking about your accounts receivables.   

What are accounts receivable? 

Accounts receivable is a common strategic approach to increasing sales volumes through the extension of credit to customers.   

Look at your financial statements and you’ll see your accounts receivables are a current asset on your company’s balance sheet. They represent the money owed to your business by customers for goods and services they’ve already received. It is an important part of your cashflow strategy.  

Key points to note are:  

  • Accounts receivable meaning is the total amount of money owing to you by your debtors for goods or services you’ve provided them.
  • Accounts receivables are recorded your balance sheet.
  • Your accounts receivable is considered a current asset.
  • Accounts receivable has strong impact on your cashflow.
  • To understand how well your accounts receivable is performing (i.e., if you’re collecting that cash back in quickly) a key metric to use is Days Sales Outstanding (DSO).
  • Managing your accounts receivables (i.e., collecting what’s owed) is commonly referred to as ‘receivables management’, ‘collections’, or ‘credit control’.   

What’s the difference between accounts receivable and accounts payable?  

They sound similar and both are common accounting terms yet accounts receivable and accounts payable speak to different areas of your balance sheet. Your accounts receivable covers the money owed to you by your debtors, the customers to whom you’ve extended credit. Your accounts payable on the other hand, is short-term debt you owe to creditors and suppliers who’ve extended credit to you. Accounts receivable is a current asset on your balance sheet, whereas accounts payable is a current liability.   

What’s an example of accounts receivable?  

To really understand the accounts receivable meaning, let’s pretend we own and run a small business. Our business specialises in delivering and maintaining indoor plants to offices and retail spaces.  

We have a strong customer base and part of our agreement with customers is to visit their sites weekly to ensure any plants we’ve delivered are well-watered and looking fresh and healthy. For this weekly service, we invoice our customers at the end of each month, with the accepted payment terms being full payment due within seven days of the invoice date (this is our credit period). We have multiple payment options and in our payment terms we’ve stipulated late fees in the event of non-payment. 

As these customers have received goods and services from us without paying up front – they are our debtors. The total amount of money owed to us by our debtors is our accounts receivable.  

Why are accounts receivable important?  

The accounts receivable process and the money attached to your accounts receivable are extremely important to your cashflow and overall success of your business. Many B2B businesses and non-FMCG B2C businesses have accounts receivables as they recognise the strategic need to offer customers credit for goods and services they supply.   

As soon as you’ve started extending credit to customers, you need to understand that good accounts receivable management is crucial to business success. A key part of the accounts receivable process is credit control. Good credit control ensures that you stay on top of your debtors, regularly conduct risk assessments of your debtors and review the level of credit you’re willing to extend. Managing your accounts receivable well will mean you can increase sales volumes, build strong customer relationships and enjoy healthy cashflow. Done poorly, accounts receivable can blow out with debtors having outstanding invoices and late payments for months. This results in bad debt and can have a severe impact on your cashflow and ability to pay your own staff and bills.   

How can you find out about a company’s accounts receivables?  

A company’s accounts receivables are reported on their balance sheet, within their financial reports. They are loaded as an asset, given that they represent money owed to them.   

To understand the health of your accounts receivables, a key measure to review regularly is your Days Sales Outstanding (DSO). Your DSO tells you how many days on average it takes your company to collect payment for the goods or services you’ve provided.   

To calculate your DSO, take your total accounts receivables and divide this by your total sales. Then multiply this by the time period. Here’s an example:  

Let’s look at a quarterly period – so 90 days. Your accounts receivables over this period are $100,000 and your total sales are $400,000. The calculation will look like this  

200,000 / 1,000,000 = 0.25  

0.25 x 90 = 22.5  

The higher your DSO, the longer it’s taking you to collect payment from your customers.   

Your DSO is a great metric to track. It should help you better understand how well you or your finance team is doing collecting payments from your customers. Importantly, understanding your DSO will also help you forecast your cashflow more accurately.   

What is the process for accounts receivable?  

The best way to wrap your head around the accounts receivable process is to look at the full order to cash cycle. Breaking it down step by step, you’ll see how it flows from being a customer strategy to generate and increase sales, through to becoming an asset that needs to be tracked and followed up.   

  • Order placed and managed: Sales close a deal. Backroom ensures the order can be fulfilled as agreed, then places orders.  
  • Credit check: Credit risk of customer is assessed. If good, then credit is extended as per usual terms. If risk is higher than acceptable, either credit terms are shortened, or customer must pay up-front prior to receipt of goods.  
  • Order fulfilled: Goods or services are provided to the customer as ordered. 
  • Customer is invoiced: An invoice is prepared and sent to the customer. 
  • Payment collection: Payment should be received as per agreed payment schedule. If payment is not received by the due date, customer is flagged for credit issues and followed-up. 
  • Cash reconciliation and management: Payment is matched to invoice and cash reconciled. Any disputes are handled via an agreed process. Late payments are followed up and escalated to through collections process.  

The easy part of accounts receivable is extending the credit to customers. The hard part can be everything after that. These days however, with advances driven by modern software and automation tools, accounts receivable doesn’t have to be a burden. Whether you manage it inhouse or outsource to a bookkeeper, accountant or outsourced credit control service, there are many software systems and apps that integrate with your accounting software to make your accounts receivable run smoothly.   

Smooth out your accounts receivables  

If you’re frustrated with unpaid invoices and your accounts receivables aren’t looking so healthy, get in touch with our team of credit management experts. Products like CreditorWatch Collect smooth the accounts receivables process for both you and your customers. It’s quick to implement and easy to use. Best of all, customers tell us they see results immediately. 

accounts receivable cash flow credit management finance small business SMEs tradereceivables
Product Marketing Manager
Lucy joined the CreditorWatch marketing team in October 2022. With experience across government, media and SMEs she loves working with companies like CreditorWatch that enable businesses large and small to improve their processes and work smarter.
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