What Is Accounts Receivable (AR)? Definition, Importance & Process

Money management can be tricky, and few areas show this better than the accounts receivable process. Basically, accounts receivable represents money that customers owe a business for goods or services they received but haven't paid for yet. Companies wait 50 to 72 days on average to handle an invoice manually, which creates the most important delays in their cash flow.

The accounting world calls accounts receivable an asset to the company. This makes sense because these future resources will turn into cash. However, the accounts receivable process goes beyond waiting for payments to arrive. An efficient AR management directly impacts liquidity and operational efficiency. And this is why  higher amounts of outstanding balances put a company's financial health at risk. 

This blog explains what accounts receivable means in accounting, how the process works, and why effective management — especially with automation — can unlock working capital and reduce collection risks.

What is Accounts Receivable?

In accounting, accounts receivable refers to the outstanding amounts customers owe after purchasing on credit. When a business delivers goods or provides services before receiving payment, those unpaid invoices are recorded as receivables. They create a legal claim to cash that will be collected later, bridging the gap between revenue earned and payment received.

This means when a business delivers a product or service but allows the customer to pay later, the amount owed is recorded as accounts receivable. In other terms, the company extends credit to its customer, which usually comes with agreed-upon payment terms, often 30, 45, or 60 days, depending on the business and industry. During this period, the unpaid invoices are tracked as accounts receivable until the customer completes payment. It also represents the money that will flow into the business in the near future.

Example of accounts receivable

To make this clear, let us look at a simple example.

Company A, the supplier, delivers office equipment to a client, Company B. Instead of asking for immediate payment, Company A issues an invoice with a 30 day credit period.

At the time of delivery, Company A records the value of that invoice under accounts receivable since the payment is still pending. Over the next 30 days, this amount remains in accounts receivable as an asset on Company A’s balance sheet.

Once Company B makes the payment within the agreed period, the pending receivable is cleared and the amount is recognized as actual revenue by Company A.

This cycle of delivering the product or service, issuing an invoice, recording it as receivable, and later collecting the payment shows how accounts receivable works in practice.

Importance of accounts receivable in accounting

Accounts receivable is important because it reflects money that will come into the business in the near future. Having a clear record of what customers owe helps owners and managers understand how much cash is available to meet expenses and plan ahead. If receivables are not tracked well, it can create cash shortages even when sales look strong on paper.

It also plays a role in how outsiders view the business. Banks, lenders, and investors often check accounts receivable to see if a company collects payments on time and can manage credit responsibly. Common measures like receivable turnover or the average number of days it takes to get paid show how efficient a business is at turning sales into actual cash. These insights make accounts receivable not only an accounting entry but also a sign of financial discipline and reliability.

Difference between Accounts Receivable and Accounts payable?

Accounts receivable (AR) represents the money your business is owed by customers. It shows up when you deliver goods or services but allow clients to pay later. Until the payment is received, the pending amount is recorded as an asset on your balance sheet because it reflects future cash inflows.

Accounts payable (AP), on the other hand, represents what your business owes to suppliers or vendors. When you purchase goods or services on credit, the outstanding invoices become a liability on your balance sheet, since they are future cash outflows.

Accounts Receivable on the Balance Sheet

Financial statements show the actual state of accounts receivable through standardized accounting practices. The balance sheet displays accounts receivable as a key component that reveals crucial details about a company's financial health.

How AR is recorded in accrual accounting

Accrual accounting records accounts receivable as a current asset on the balance sheet. This represents money customers owe to the company for goods or services delivered but not yet paid for. Revenue recognition happens at the time it is earned, whatever the timing of cash payment might be.

The standard journal entry to record accounts receivable has these steps:

1. Debiting accounts receivable (increasing this asset)
2. Crediting sales revenue (recognizing income earned)

To cite an instance, a business that invoices a customer for $500 would make this entry:

Account	Debit	Credit
Accounts Receivable	$500
Revenue		$500

Payment receipt leads to another entry that completes the cycle:

Account	Debit	Credit
Cash	$500
Accounts Receivable		$500

Accounts receivable examples in financial statements

Accounts receivable directly affects a company's liquidity position on the balance sheet. Here's a simple example:

The original balance sheet shows accounts receivable of $100,000. Credit sales of $200,000 in April increase accounts receivable to $300,000. Collections of $100,000 in May reduce accounts receivable to $200,000.

Accounts receivable affects other financial statements too:

• Income Statement: Credit sales increase revenue; uncollectible amounts may become bad debt expenses
• Cash Flow Statement: Changes in accounts receivable appear in the operating activities section and show collection efficiency

Net receivables and doubtful accounts

Companies cannot collect all accounts receivable. They report net receivables—the realistic amount they expect to collect after adjusting for potential uncollectible accounts.

A simple formula calculates net receivables: Net Accounts Receivable = Accounts Receivable – Allowance for Doubtful Accounts

The allowance for doubtful accounts acts as a contra-asset that reduces the accounts receivable balance on the balance sheet. A company with $500,000 in accounts receivable might estimate $20,000 as uncollectible, making net receivables $480,000.

Companies typically make this journal entry to establish the allowance:

Account	Debit	Credit
Bad Debt Expense	$20,000
Allowance for Doubtful Accounts		$20,000

This accounting method will give a true picture of expected resources. It improves accuracy in financial reporting and prevents major fluctuations when accounts become uncollectible.

Types of Accounts Receivable

Not all receivables are the same. Depending on the nature of the transaction and the agreement with a customer, businesses can categorize their receivables into different types. Recognizing these distinctions helps companies manage collections more effectively and understand where potential risks may lie.

1. Trade Receivables

Trade receivables are perhaps the most common type. They represent amounts owed by customers for goods or services delivered as part of regular business operations. Usually, these invoices are recorded right after the sale. For example, if a supplier ships products with a 30-day credit term, the invoice would be classified as a trade receivable. These receivables often make up the largest portion of a company’s outstanding invoices.

2. Notes Receivable

Notes receivable are a bit more formal. They involve a written promise from the customer to pay a specific sum by an agreed-upon date, often including interest. These are typically used for larger transactions or longer-term agreements. Because they are legally binding, notes receivable are generally considered more secure than standard trade receivables, giving the company greater assurance of payment.

3. Other Receivables

This category covers any receivable that doesn’t stem from core operations. Examples include:

• Tax refunds owed by government authorities
  
• Advances paid to employees or suppliers
  
• Pending insurance claims
  

Even though these amounts might be smaller or less frequent, they still affect the company’s cash flow and overall working capital.

4. Unbilled Receivables

Unbilled receivables occur when products or services have been delivered but an invoice hasn’t been issued yet. These amounts are still recorded as assets because the company expects payment. Professional service firms often deal with unbilled receivables for ongoing projects, where work is delivered in phases before billing is generated.

Steps in accounts receivable process

The accounts receivable process covers a series of well-laid-out steps that finance teams use to collect payment for credit sales. Credit sales differ from cash transactions because customers receive products or services before paying. Let's get into how this financial workflow runs from beginning to end.

Step 1: Extending credit to customers

Companies must review whether potential customers qualify for credit terms. The process starts with clear credit policies that show eligibility requirements, credit limits, and payment expectations. Most B2B transactions work on credit, which makes this assessment vital for financial health. Companies take these steps before offering credit:

·       Review the customer's credit history and financial stability

·       Conduct a formal credit application process

·       Set appropriate credit limits based on risk assessment

·       Document credit terms in a formal agreement

A clear credit policy protects businesses from too much risk. Credit extension shows financial stability but creates exposure to possible bad debt.

Step 2: Issuing and sending invoices

The next vital step after delivering goods or services involves creating and sending invoices quickly. The invoice stands as the definitive record of the customer's purchase and shows:

·       Exact products or services provided

·       Total amount due and payment terms

·       Payment due date (typically 30, 60, or 90 days)

·       Any applicable late payment fees

Quick invoice delivery affects when payment terms start. Many businesses now use accounting software, EDI (Electronic Data Interchange), or email to send invoices faster than traditional mail.

Step 3: Recording AR in accounting systems

The accounting system needs proper transaction records after invoice sending. Teams create journal entries that follow double-entry accounting principles:

1.       Debit the accounts receivable account (increasing this asset)

2.       Credit the sales or revenue account (recognizing earned revenue)

This organized documentation ensures credit sales appear correctly on financial statements. The process maintains accurate accounts receivable balances on the balance sheet while tracking revenue properly.

Step 4: Following up and collecting payments

AR teams must actively manage collections throughout the payment cycle. Different follow-up levels become necessary as invoices age:

·       Under 7 days past due: Initial gentle reminder

·       8-14 days past due: Second customer contact

·       15-30 days past due: Third contact and possible dunning letter

·       31-45 days past due: Fourth contact with final notice

·       46-60 days past due: Regular outreach (approximately every 5 business days)

·       61-90+ days past due: Potential escalation to management, legal counsel, or collection agencies

Teams should investigate disputes early because collection probability drops over time. Professional communication helps maintain customer relationships throughout this process.

Step 5: Reconciling and closing the AR cycle

The final step matches payments received against outstanding invoices. This reconciliation process has these steps:

3.       Matching incoming payments with their corresponding invoices

4.       Recording transactions in the accounts receivable ledger

5.       Applying appropriate credits or discounts before closing

6.       Updating the general ledger to reflect payment

Finance teams verify all transaction records during month-end closing. They compare the accounts receivable ledger with detailed subledger records. This verification ensures financial statements show the company's AR status accurately and completes the accounts receivable cycle.

Key Metrics to Track Accounts Receivable Performance

Finance teams need to track specific financial metrics to understand their collection efficiency and cash flow health. These indicators help them spot potential problems, make better decisions, and streamline their receivables management.

Accounts receivable turnover ratio

The accounts receivable turnover ratio shows how often a company collects its average accounts receivable balance in a given period. This efficiency metric tells you how well a business turns credit sales into cash, which directly affects its liquidity and operations.

The calculation is straightforward - divide net credit sales by average accounts receivable:

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Average accounts receivable equals (Beginning AR + Ending AR) / 2.

A higher ratio means more frequent collection of outstanding balances, which suggests your collection process works well and you have reliable customers. A ratio of 8 tells you the company collects its average receivables eight times per year, roughly every 45 days. On the flip side, a consistently low ratio might point to weak collection procedures or problematic credit policies.

Days sales outstanding (DSO)

Days sales outstanding (DSO) tells you how fast a business converts credit sales into cash by measuring the average collection time after a sale. This number plays a crucial role in working capital management and overall cash flow health.

Here's how to calculate DSO: DSO = (Accounts Receivable / Credit Sales) × Number of Days

The ideal DSO varies by industry, but lower numbers usually mean better cash flow and more effective collections. Most companies see a DSO below 45 as healthy, indicating good cash flow. To cite an instance, a DSO of 45 means customers take about 45 days to pay after purchase.

Your finance team should watch DSO trends rather than single measurements because steady increases could mean your collection process needs attention or customers are having payment issues.

Aging schedule and overdue buckets

An aging schedule groups unpaid invoices by age, usually in 30-day chunks: current (0-30 days), 31-60 days, 61-90 days, and over 90 days past due. This breakdown helps you spot receivables that might be delayed or defaulted.

The aging schedule gives you valuable insights:

·       Shows which customers regularly pay late 

·       Reveals possible cash flow problems when invoices pile up in older buckets 

·       Indicates when collection strategies need changes

·       Makes cash flow forecasting more accurate

Industry data shows that collection chances drop substantially as invoices age—recovery becomes much harder for invoices past 90 days. The 31-60 day bucket typically doubles your collection time compared to current invoices, with DSO averaging 45-55 days.

Your company should keep less than 15% of total accounts receivable in the over-90-days bucket to avoid financial pressure.

Benefits and Risks of Managing AR Effectively

Good accounts receivable management gives businesses substantial advantages and reduces financial risks. Companies that become skilled at accounts receivable practices build a strong base to run smoothly and grow strategically.

Improved cash flow and liquidity

Businesses collect customer payments faster when accounts receivable decreases, which boosts overall liquidity. A better cash position lets organizations meet their financial commitments and invest in new opportunities. Quick handling of receivables improves cash flow directly and creates an ongoing cycle of financial health. Companies with streamlined accounts receivables can also maintain steady cash coming in that lines up with outgoing payments. This helps maintain liquidity without extra borrowing.

Better customer relationships

The benefits go beyond finances - good AR management helps build strong customer connections substantially. Companies that pay attention to customer needs through customized payment plans show they understand each customer's financial situation. This encourages loyalty and trust. The option to pay in different ways enables customers and speeds up payment processing. A problem-solving approach to handling disputes leaves customers with a positive impression. They are then more likely to stay with the business.

Risks of bad debt and late payments

Credit risk shows up whenever businesses offer goods or services on credit terms. Payment risk - where customers might not pay on time - combined with collection risk - the challenge of recovering pending payments - can affect operations heavily. These risks threaten cash flow, profits, and the ability to pay bills. Unpaid receivables mean lost revenue and hurt key financial metrics. This can make businesses less attractive to investors and lenders.

Impact on working capital

Large accounts receivable balances often show that sales aren't converting to cash efficiently, which hurts working capital. Companies may struggle to manage inventory, pay suppliers, or handle other daily expenses when too much capital gets stuck in accounts receivable. Quick collection ensures businesses avoid unnecessary cash shortages that could limit daily operations and growth chances. The health of cash flow shapes a company's ability to invest, expand, and succeed in competitive markets.

Common Challenges in Accounts Receivable

Managing accounts receivable is rarely without hurdles. Many companies struggle with issues that slow down cash flow and make financial planning more difficult.

Late Payments and Slow Collections
One of the biggest headaches is simply waiting for customers to pay. Even when invoices are accurate and delivered on time, delays in payment can tie up funds that are crucial for daily operations. Slow collections can impact payroll, vendor payments, and investment opportunities.

Manual Processes and Errors
Relying on spreadsheets or paper-based AR systems often leads to mistakes. Data entry errors, lost invoices, or misapplied payments can create confusion and consume hours of manual reconciliation.

Disputes and Invoice Inaccuracies
Sometimes payments are delayed because of disagreements. Perhaps a shipment was partially delivered, or the invoice contains a minor error. Resolving these disputes takes effort, prolongs the payment cycle, and can strain customer relationships.

Limited Visibility into Receivables
Without clear insights, finance teams may struggle to know which invoices are overdue or which customers habitually delay payments. This makes it difficult to prioritize collection efforts or accurately forecast cash flow.

How Automation is Changing Accounts Receivable

Companies can overcome these obstacles by implementing clear credit policies, leveraging AR reporting tools for visibility, and automating repetitive tasks. By combining process improvements with the right technology, businesses reduce errors, collect payments faster, and maintain strong relationships with customers.

Modern AR automation goes beyond just speeding up collections—it transforms how finance teams operate.

Faster and Accurate Invoice Generation
Automation tools generate invoices instantly and deliver them through multiple channels. This ensures invoices reach customers promptly, reducing delays that typically occur with manual methods.

AI-Powered Payment Matching
Automated systems can identify incoming payments and match them to the correct invoices. This minimizes human errors and speeds up reconciliation, freeing teams from tedious tasks.

Smarter Collections Management
AR automation allows finance teams to set up automated reminders, follow-ups, and escalation rules. The system can even track disputes and prioritize collection efforts, ensuring no overdue account slips through the cracks.

Real-Time Reporting and Analytics
Dashboards provide instant visibility into AR performance. Teams can track DSO trends, monitor overdue invoices, and understand customer payment behavior. These insights support better decision-making and improve cash flow forecasting.

The Big Picture
With automation, companies not only collect payments faster but also operate more strategically. Tools like HighRadius' accounts receivable software use agentic AI to optimize AR workflows, reduce DSO, and boost team efficiency. By taking routine tasks off human hands, finance teams can focus on higher-value activities, like improving customer experience and planning growth initiatives.

FAQs

1. What is the accounts receivable (AR) process in accounting?

The accounts receivable process involves tracking and managing money owed to a business for goods or services provided on credit. It includes steps like extending credit, issuing invoices, recording transactions, following up on payments, and reconciling accounts. This process helps businesses maintain cash flow and manage customer debts effectively.

2. How does accounts receivable impact a company's financial health?

Accounts receivable directly affects a company's cash flow, liquidity, and working capital. Efficient AR management leads to faster payment collection, improved cash flow, and better financial stability. However, high AR balances or slow collections can tie up capital and potentially lead to cash flow issues.

3. What are some key metrics for evaluating accounts receivable performance?

Important metrics for assessing AR performance include the accounts receivable turnover ratio, which measures how quickly a company collects payments, and days sales outstanding (DSO), which indicates the average time taken to collect payment after a sale. Additionally, aging schedules help track overdue invoices and identify potential collection issues.

4. What is the accounts receivable (AR) process?

It is the series of steps to track and collect payments owed by customers, including credit extension, invoicing, transaction recording, collections, and reconciliation. It ensures businesses maintain healthy cash flow, reduce payment delays, and keep accurate financial records.

5. How can businesses improve their accounts receivable management?

Businesses can enhance AR management by implementing clear credit policies, sending invoices promptly, following up on payments regularly, offering multiple payment options, and utilizing AR automation software. These practices can speed up collections, reduce bad debts, and improve overall financial efficiency.

6. What are the benefits of automating the accounts receivable process?

Automating accounts receivable can significantly improve efficiency by reducing manual data entry, minimizing errors, and speeding up invoice processing and payment matching. It allows for better tracking of customer payments, provides real-time insights into AR status, and frees up staff time for more strategic tasks, ultimately leading to improved cash flow and customer relationships.