Is Accounts Receivable an Asset or Liability? Explanation and Examples

Introduction

When a company sells goods on credit, the entries for the transactions are made using accounts receivable. It is crucial to comprehend the concept of accounts receivable, as its proper management holds the key to accurate financial records. Mismanaging these accounts can have detrimental effects on your cash flow, potentially leading to a shortage of available funds.

So how do you get it just right?

That’s what we’re going to explore in this post. We’ll give you the ins and outs of accounts receivable, clarify its classification as either an asset or a liability, and offer illustrative examples to underscore its utmost significance in effective financial management.

What is Accounts Receivable and How Does It Work?

Accounts Receivable (AR) is the amount of money that a company is yet to receive from its customers in return for the goods sold or services delivered. Since most B2B businesses operate on credit, a sale is recorded under AR until a customer clears the payment and it’s converted to cash.

Typically, businesses allow their clients a grace period of 30-90 days to make payment after goods or services are delivered. If the customer fails to pay within this time frame, the amount owed is deducted from accounts receivable and added to bad debt. This means that a company’s accounts receivable may not always translate to revenue and profits, as some accounts may go unpaid.

Then the question is whether accounts receivable is an asset or liability. We’ll discuss this in detail in the next section, so keep reading to learn more.

Is Accounts Receivable an Asset?

Accounts receivable is recorded as an asset on your balance sheet. Accountants typically categorize it as a current asset. It represents money owed to the company and generates economic rewards. It is also a measure of the efficiency of a company’s operations.

To fully grasp why AR is an asset, it’s essential to define what an asset is, as well as what a liability is. The following table outlines the contrasting characteristics of an asset and a liability, providing a useful summary of the differences between the two.

When a company delivers goods or services to its customers, it records the transaction as accounts receivable. As long as the company expects to collect the payment in less than a year, it falls under the category of current assets. However, if the accounts receivable remains stagnant for more than 12 months, it gets converted to long-term fixed assets.

A high accounts receivable balance indicates that a company is finding it difficult or is unable to collect payments on time. In such cases, businesses deal with the situation by offsetting bad debt with an allowance for doubtful accounts. For smaller transactions, a company might opt for direct write-offs as a loss or expense.

To sum it up, accounts receivable is an asset that represents money owed to the company and generates economic rewards. However, if a company fails to collect accounts receivable, it can become a liability.

How Can Businesses Benefit from Accounts Receivable?

Accounts receivable (AR) is a valuable asset that can benefit businesses in numerous ways. Although not all AR converts to cash, provisions are made for bad debts through an allowance. Here are some ways in which a company’s receivables can help them even before they are converted to cash:

1. Helps in raising money by discounting AR invoices

AR can be used as collateral for loans or can be sold to investors at a discount. For instance, a company with an order size of $2 million but lacks the capital of $1 million needed to fulfill the order can list its accounts receivable contract for sale at a 10% discount. The buyer of the contract pays the company $1.8 million in advance to fulfill the order, and whenever the company makes the payment, the buyer receives it, thus making a profit.

2. Assists in easy loan approvals

A high accounts receivable balance and low bad debt indicate that a company is doing well as it has a healthy sales volume and is converting it to cash. This improves the business’s credit score and makes it easier for them to get low-interest loans for future endeavors.

3. Provides insights into business operations

By monitoring accounts receivable, businesses can gain valuable insight into their operations. For instance, they can identify which customers are paying on time and which ones are consistently late in their payments. By doing so, businesses can create strategies to deal with delinquent customers, such as offering discounts for early payments or implementing stricter payment terms.

4. Helps in forecasting future cash flow

By tracking accounts receivable and analyzing past payment trends, businesses can forecast future cash flow more accurately. This helps in managing cash flow better and making informed decisions about investments, expenses, and growth strategies.

5. Reduces administrative workload

Automating accounts receivable management using technology can reduce the administrative workload and free up time for more critical tasks. With technology, businesses can send automated payment reminders, receive payments electronically, and track customer payment history, among other things.

Leveraging Automation for Efficient Accounts Receivable Management

Effective accounts receivable management is vital for businesses to maintain a healthy cash flow and financial position. However, managing AR can be challenging, especially for companies with high transaction volumes. The traditional manual processes of managing AR are time-consuming, prone to errors, and often require significant resources.

Fortunately, advancements in technology have made it possible to automate accounts receivable management, bringing significant benefits to businesses. Here are some of the benefits of leveraging automation for efficient accounts receivable management:

1. Faster Receivables Conversion due to Connected A/R Processes: Automation enables businesses to connect multiple ERP systems in one platform, providing enhanced visibility and making data-driven decisions. By automating the process, businesses can track invoices from creation to payment, reducing errors and delays. This results in faster receivables conversion and improved cash flow.
2. A/R Teams Able to Focus on High-Value Tasks: Automation eliminates repetitive, manual work and replaces paper-based functions. This frees up A/R staff to focus on qualitative analysis, such as identifying delinquent customers, creating strategies to deal with them, and improving customer relationships.
3. 360-Degree Visibility of Global Process Health: Automation provides access to out-of-box dashboards, enabling businesses to gain visibility of global A/R health, benchmark against best-in-class peers, and track analyst performance against goals. This allows businesses to make informed decisions to improve their operations and stay ahead of the competition.

Conclusion

Effective accounts receivable management is crucial for the financial health of any company. Devoting time and effort to improve the process is well worth it, as an optimized and efficient A/R process can yield positive effects on various functions, from marketing and sales to customer service and overall operations. However, manual accounts receivable processes can be time-consuming, error-prone, and result in poor cash flow, high DSO, and an extended order-to-cash cycle.

To overcome these challenges, businesses need to leverage automation and make their invoicing, credit, and collection methods more efficient. By automating accounts receivable processes, businesses can reduce the administrative workload, free up resources, and focus on high-value tasks.

At HighRadius, we offer an Autonomous Receivables solution that enables businesses to automate their accounts receivable processes, providing faster receivables conversion, improved cash flow, and better decision-making. Our solution leverages AI and machine learning algorithms to streamline the entire AR process, from invoice creation to cash application.

With HighRadius’ Autonomous Receivables solution, businesses can gain 360-degree visibility of their global process health, benchmark against best-in-class peers, and track analyst performance against goals. This enables businesses to make informed decisions to improve their operations and stay ahead of the competition.

Ready to automate your accounts receivable and move towards success? Schedule a demo with us today to learn how HighRadius’ Autonomous Receivables solution can benefit your business.

FAQs on Accounts Receivable

1. Is Accounts Receivable Considered an Asset?

   Accounts receivable is an asset as it represents money owed to the company, generates economic rewards, and is a measure of a company’s operational efficiency. It falls under the category of current assets and helps businesses forecast future cash flow.

2. What type of asset is accounts receivable?

   Accounts receivable is a current asset that represents money owed to a company by customers for goods or services provided. It is expected to be converted into cash within a year and is an essential component of a company’s working capital management.

3. How do you record account receivables?

   To record accounts receivable, create an invoice when goods or services are sold on credit. This invoice will show the amount due and payment terms. When payment is received, record the transaction in the accounts receivable ledger, updating the balance and recognizing cash received.