Why do companies use accounts receivable?
Companies use an account receivable to extend credit to customers, encourage purchases, and increase sales without requiring immediate payment. An efficient accounts receivable process helps you track invoices, monitor payment deadlines, and reduce overdue balances.
The accounts receivable-to-accounts payable (AR/AP) ratio compares incoming customer payments with amounts owed to suppliers. A 2:1 ratio is sometimes used as a general guideline, indicating twice as much AR as AP, although the ideal ratio varies by business. A 1:1 ratio may indicate tighter cash flow if customers pay late. Lenders and investors may assess these figures when evaluating financial stability.
Maintaining healthy receivables and predictable cash flow can support your business loan application with Bajaj Finance.
What is included in accounts receivable?
An account receivable includes money owed to a business for credit sales, services, rent, subscriptions, and interest. These accounts receivable examples cover common types of trade receivables and other outstanding payments that contribute to your expected revenue.
| Type | Description | Accounts receivable examples |
|---|
| Trade receivables | Money owed for goods or services sold on credit | A retailer’s unpaid invoice from a manufacturer |
| Notes receivable | A formal promissory note from a customer | A signed agreement to pay Rs. 5 lakh in instalments |
| Rent receivables | Unpaid rent from tenants | Monthly rent due from a commercial tenant |
| Subscription receivables | Recurring fees not yet collected | An outstanding annual software subscription payment |
| Interest receivables | Interest owed under a payment arrangement | Interest accrued on a deferred payment agreement |
How does the accounts receivable process work?
The accounts receivable process begins with assessing a customer’s creditworthiness before a sale and ends with payment collection, account reconciliation, and reporting.
- Assess creditworthiness: Check the customer’s payment history and credit risk before offering credit.
- Deliver goods or services: Fulfil the purchase agreement and document delivery.
- Issue an invoice: Send an accurate invoice promptly, stating the payment due date.
- Record the receivable: Enter the amount owed as an account receivable in your accounting system.
- Record payment: When payment arrives, record the receipt and clear the outstanding AR entry.
- Follow up on overdue payments: Send reminders, apply agreed late fees where lawful, and escalate unpaid invoices.
- Reconcile and report: Review balances and generate ageing reports regularly.
Reconcile your records regularly and use the account receivable formula to track outstanding balances accurately.
What are the risks of outstanding accounts receivable balances?
Outstanding accounts receivable can strain cash flow, delay business payments, and increase the risk of unpaid invoices. Large overdue balances can also affect investor confidence and a company’s creditworthiness.
- Cash flow shortages: Delayed customer payments can leave insufficient funds for wages, rent, and supplier invoices.
- Increased bad debt: Collection becomes more difficult as invoices age, particularly beyond 90 days past due.
- Higher administration costs: Repeated reminders, follow-ups, and collection efforts consume staff time and resources.
- Lower business valuation: Persistently high overdue receivables may concern investors and lenders assessing financial stability.
What are the accounts receivable write-off bad debt methods?
The direct write-off method removes an amount when it is deemed uncollectible, while the allowance method estimates potential losses in advance and maintains an allowance for doubtful accounts. The allowance method is generally preferred under accrual accounting standards.
Use an accounts receivable aging schedule to identify overdue invoices and prioritise collection efforts.
What are the benefits of accounts receivable (AR)?
Accounts receivable enables credit sales, helping businesses attract customers, increase revenue, and support growth by allowing buyers to pay after receiving goods or services.
- Revenue growth: Offering credit can encourage repeat purchases and help businesses build long-term customer relationships.
- Cash flow planning: Tracking payment due dates helps you anticipate incoming funds and plan expenses more effectively.
- Financial flexibility: An efficient accounts receivable process helps reduce overdue invoices and maintain more predictable working capital.
- Better financial visibility: Regularly reviewing outstanding invoices and payment patterns helps identify collection risks before they escalate.
Well-managed AR also signals financial discipline to lenders and investors. A low proportion of overdue invoices can strengthen your business’s financing profile when applying for a business loan from Bajaj Finance.
Accounts receivable examples across industries
Accounts receivable examples most commonly include unpaid invoices for goods or services supplied to customers on credit. These trade receivables represent money a business expects to collect after completing a sale or service.
- Retail: Outstanding invoices for goods supplied to shops.
- Manufacturing: Payments due from distributors for products delivered on credit.
- Utilities: Unpaid electricity, water, or gas bills.
- Software: Outstanding monthly or annual subscription fees.
- Professional services: Unpaid fees for consultancy, accounting, or legal services.
- Commercial property: Rent due from tenants under lease agreements.
What is the account receivable journal entry?
Under accrual accounting, a business records revenue when goods are delivered on credit, even if payment arrives later. For example, a business makes a credit sale of Rs. 1,00,000.
| Transaction | Account | Debit | Credit |
|---|
| Goods delivered on credit | Accounts Receivable | Rs. 1,00,000 | — |
| Goods delivered on credit | Sales Revenue | — | Rs. 1,00,000 |
| Payment received | Cash | Rs. 1,00,000 | — |
| Payment received | Accounts Receivable | — | Rs. 1,00,000 |
Businesses that manage receivables effectively can improve working capital planning and strengthen their profile when applying for a business loan from Bajaj Finance. Use the account receivable formula to track outstanding balances accurately.
What is the account receivable formula?
The account receivable formula calculates the ending accounts receivable balance by adding credit sales to beginning AR and subtracting collections and write-offs.
Ending accounts receivable formula
Ending AR=Beginning AR + Credit Sales - Collections - Write-offs
For example, if beginning AR is Rs. 20,000, credit sales are Rs. 50,000, collections are Rs. 30,000, and write-offs are Rs. 0, ending AR is Rs. 40,000.
AR turnover ratio: Net credit sales ÷ Average AR.
AR journal entry
| Account | Debit | Credit |
|---|
| Accounts Receivable | Rs. 50,000 | — |
| Sales Revenue | — | Rs. 50,000 |
| Cash (payment received) | Rs. 50,000 | — |
| Accounts Receivable (payment received) | — | Rs. 50,000 |
Reconcile these entries regularly as part of your accounts receivable process to keep balances accurate and identify overdue payments.
What is an accounts receivable aging schedule?
An accounts receivable aging schedule categorises outstanding invoices by how long they have remained unpaid, helping you assess collection risks and prioritise follow-ups.
| Aging bucket | Definition | Accounts receivable collection risk |
|---|
| Current | Payment is within agreed terms | Low — follow standard payment procedures |
| 1–30 days | Slightly overdue | Low to medium — send a reminder |
| 31–60 days | Noticeably overdue | Medium — contact the customer directly |
| 61–90 days | Seriously overdue | High — issue a formal collection notice |
| 90+ days | Severely overdue | Very high — consider legal action or a write-off after reviewing recoverability |
As invoices age beyond 60 days, collection efforts should become more urgent. To understand when should accounts receivable be escalated, establish clear escalation deadlines and assign responsibility for each overdue account.
What is the accounts receivable turnover ratio?
The accounts receivable turnover ratio measures how efficiently a business collects credit sales, calculated by dividing net credit sales by average accounts receivable.
Account receivable formula:
Turnover Ratio = Net Credit Sales/Average AR
For example, if net credit sales are Rs. 12,00,000 and average accounts receivable is Rs. 1,00,000, the turnover ratio is 12, indicating collections approximately every 30 days.
| Turnover ratio | What it means | Typical payment terms alignment |
|---|
| 12 or higher | Collections approximately every 30 days | Consistent with Net 30 terms |
| 6 | Collections approximately every 60 days | Consistent with Net 60 terms; slow for Net 30 |
| Below 4 | Collections every 90 days or longer | Investigate overdue accounts and credit risks |
Interpret the ratio against your industry, customer payment terms, and seasonal sales patterns, as collection cycles vary between businesses.
How does accounts receivable affect financial statements?
Accounts receivable appears as a current asset on the balance sheet and represents revenue earned but not yet collected from customers.
- Balance sheet: AR increases current assets until customers settle their outstanding invoices.
- Income statement: Credit sales increase recognised revenue when goods or services are delivered under accrual accounting.
- Cash flow statement: AR affects operating cash flow because an increase in unpaid invoices can reduce cash collected from customers. The account receivable formula helps track changes in outstanding balances.
- Bad debt provision: Expected credit losses may require an allowance for doubtful accounts, reducing the reported net value of receivables.
Under accrual accounting, revenue is recognised when earned, whereas cash-basis accounting records revenue only when payment is received. The appropriate treatment depends on the applicable accounting framework and requirements.
Accounts receivable vs. accounts payable: key differences
Accounts receivable vs accounts payable describes money coming into a business versus money going out. AR represents amounts customers owe you, while accounts payable (AP) represents amounts your business owes suppliers.
| Feature | Account receivable (AR) | Accounts payable (AP) | Impact |
|---|
| Meaning | Money owed by customers | Money owed to suppliers | Tracks incoming and outgoing payments |
| Balance sheet | Current asset | Current liability | Influences working capital |
| Transaction | Credit sales | Credit purchases | Records business transactions |
| Cash flow | Cash expected from customers | Cash required for payments | Affects liquidity |
| Management priority | Collect invoices promptly | Pay suppliers on time | Supports financial stability |
| AR/AP ratio | Compares receivables with payables | Provides the comparison base | Helps assess liquidity |
A 2:1 AR/AP ratio is sometimes used as a general guideline, meaning receivables are twice payables, but the appropriate ratio depends on the business and its payment cycles.
What are the other types of accounts receivable?
Accounts receivable includes two main categories: trade receivables, arising from credit sales to customers, and non-trade receivables, arising from other transactions. These categories include amounts due through loans, rent, interest, and formal payment agreements.
| Type | Description | Example |
|---|
| Trade receivables | Amounts due from standard credit sales | Unpaid invoice from a retailer |
| Notes receivable | Formal promissory note documenting repayment | Rs. 5 lakh instalment commitment |
| Rent receivables | Unpaid rent from tenants | Monthly rent due for commercial property |
| Loan receivables | Amounts lent to employees or related parties | Staff advance repayable through salary |
| Interest receivables | Interest accrued on deferred payment arrangements | Interest due on a 90-day credit arrangement |
Which documents support accounts receivable recovery?
The invoice is the most essential document for accounts receivable recovery because it records the amount owed, payment due date, and payment instructions. Other documents help establish the transaction and support recovery efforts if payment is delayed or disputed.
- Invoice: Records the amount due, due date, and payment instructions.
- Purchase order (PO): Confirms the customer’s original order and agreed requirements.
- Delivery receipt or proof of delivery: Demonstrates that the goods or services were provided.
- Credit agreement or sales contract: Documents payment terms, credit limits, and agreed late-payment penalties.
- Payment reminder correspondence: Provides a record of follow-ups and the customer’s responses.
- Demand letter: Formally requests payment of the outstanding amount before potential legal action.
Retain accounts receivable records securely, including invoices, contracts, delivery evidence, and correspondence, in line with applicable legal and business record-retention requirements.
When should accounts receivable be escalated for collection?
Accounts receivable escalation should generally begin when an invoice is 30 days past due, with stronger recovery measures introduced as the outstanding balance ages.
- 0–30 days past due: Use an accounts receivable aging schedule to track invoices, send automated reminders, and confirm receipt. No formal escalation is usually needed.
- 31–60 days past due: Contact the customer directly by phone or email. Consider a payment plan if cash flow difficulties are reported.
- 61–90 days past due: Send a formal demand letter, involve senior management, and apply contractually agreed late fees where permitted.
- 90+ days past due: Consider a collection agency or legal advice, based on the amount owed and recovery prospects.
Treat an accounts receivable write-off for bad debt as a last resort after reasonable recovery efforts and an assessment of collectability.
Can discounting early payments improve accounts receivable turnover?
Yes, offering early-payment discounts can improve the accounts receivable turnover ratio by encouraging customers to settle invoices sooner and reducing collection periods.
Under a 2/10 Net 30 arrangement, customers receive a 2% discount if they pay within 10 days instead of the standard 30 days. For an invoice of Rs. 1,00,000, the customer pays Rs. 98,000 within 10 days, saving Rs. 2,000.
Account receivable formula:
Accounts receivable turnover ratio = Net credit sales ÷ Average AR.
For example, improving turnover from 6 to 9 times annually reduces the average collection period from approximately 60 to 40 days.
However, discounts reduce revenue per invoice. Assess whether the savings from faster collections outweigh the discount cost before changing your accounts receivable policy.
Conclusion
Accounts receivable is an integral part of any business’s financial management. It not only supports stable working capital but also ensures a consistent flow of funds necessary for day-to-day operations. By efficiently managing AR, businesses can minimise risks such as bad debts, enhance profitability, and strengthen their financial position. Bajaj Finance offers tailored solutions for optimising AR processes, helping businesses streamline collections and improve cash flow. Additionally, effective AR management enhances eligibility for a business loan, empowering companies to fund growth and achieve long-term success.
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