Trade receivables is the amount that customers owe a business for the goods or services provided. It is the same as accounts receivable and comes under the current asset category on a balance sheet.
Most B2B businesses offer goods and services to customers on credit. Trade receivables is the amount that customers owe to a business when buying a product or service on credit. It is a key line item in the balance sheet and is listed under the current assets section due to its short conversion time into cash.
Trade receivables are called so because they arise from business trade deals between the company and a customer. A company’s balance sheet also has non-trade receivables, which make up the amount they will receive from other sources like tax rebates, refunds, insurance claims, and so on.
A business can calculate its trade receivables by summing up the amount that all its customers owe them. It is generally divided into two parts called debtors and bill receivables.
Trade Receivables = Debtors + Bill Receivables
Bill receivables are a formal agreement between a customer and the business agreeing to pay a certain amount within a particular period for the goods or services they receive. On the other hand, debtors are the bill receivables that remain unfulfilled on the due date.
Company XYZ has bill receivables worth $150,000 and debtors worth $35,000 on its balance sheet. It also has an annual revenue of $750,000.
Trade receivables = Debtors + Bill Receivables
= $35,000 + $150,000
So, the total trade receivables of Company XYZ is $185,000.
Trade receivables as a standalone metric don’t tell much about a business’s financial position. However, we can calculate the days sales outstanding (DSO) of a business with the trade receivables and annual revenue figures.
DSO is indicative of a business’s ability to collect payments on time. Comparing it with the industry average DSO can help conclude if the business has a good cash flow or not.
A business’s DSO must be as close to the industry average as possible if it wants to perform well. A low DSO is always preferred, but the business might be losing out on potential customers due to stringent credit terms if the DSO is too low. On the contrary, a high DSO means poor cash flow and low working capital.
Let’s continue with the example from above. We found that the trade receivables for Company XYZ is $185,000, and they have annual revenue of $750,000.
DSO = (trade receivable/ annual revenue)*365
=89.79 ≈ 90 days
So, the DSO of company XYZ is 90 days.
Now, let’s say that Company XYZ is in the petroleum refining industry that has an average DSO of 25 (Source); then, comparatively, its DSO is very high and needs to be reduced. However, if it is in the building construction industry, then their 90 days DSO is very close to the industry average of 83, which is good.
Trade receivables are an asset for a company. But if a business is not cash-rich and needs funds immediately for any reason, it can opt for trade receivables financing. Trade receivable financing allows businesses to raise funds against the invoices that customers owe them.
For example, let’s say company A receives an order to produce 100,000 chocolate bars for $800,000 which will be paid within 45 days by the customer. However, to produce the order, company A needs to procure raw materials, for which it needs capital. So, company A can use trade receivables financing to raise funds and fulfill the order.
There are two main ways by which a company can finance its trade receivables. They are:
Trade receivables fall under current assets on a balance sheet because they are expected to convert into cash in less than a year.
Non-trade receivables are also assets, but as the name suggests, it doesn’t arise from the sale of goods or services. For example, insurance payouts or tax rebates on a balance sheet will fall under non-trade receivables until they are converted to cash.
Automate invoicing, collections, deduction, and credit risk management with our AI-powered AR suite and experience enhanced cash flow and lower DSO & bad debtTalk to our experts
The HighRadius RadiusOne AR Suite is a complete accounts receivable’s solution designed for mid-sized businesses to put their order-to-cash on auto-pilot with AI-powered solutions. It leverages automation to fast-track key accounts receivable functions including eInvoicing & Collections, Cash Reconciliation, and Credit Risk Management powered by RadiusOne AR Apps to improve productivity, maximize working capital, and enable faster cash conversion. Affordable, quick to deploy, and functionality-rich: it is pre-loaded with industry-specific best-practices and ready-to-plug with popular ERPs such as NetSuite and Sage Intacct. The HighRadius RadiusOne AR Suite is designed to automate labor-intensive processes while streamlining credit and collections activities for faster AR processing, better cash flow and improved profitability.
Lightning-fast Remote Deployment | Minimal IT Dependency Prepackaged Modules with Industry-Specific Best Practices.