Receivables
A guide to understanding the money owed to a company by its customers and other parties, and how this asset impacts liquidity and financial health.
Receivables are amounts owed to a company by others (usually customers) for goods or services already delivered. In other words, when a business sells on credit, it creates a receivable - a claim on future payment. For example, if Company A sells $10,000 of goods on 30-day credit, it will record an accounts receivable of $10,000 until the customer pays. Because the seller expects to receive that cash later, receivables are recorded as assets on the balance sheet, typically as current assets since they are expected to be collected in the near term.
Types of Receivables
While often used interchangeably with 'Accounts Receivable,' the term 'Receivables' can encompass several distinct types of claims:
- Accounts Receivable (or Trade Receivables): This is the most common type, arising from the ordinary course of business when a company sells its goods or services on credit.
- Notes Receivable: These are more formal credit arrangements backed by a signed promissory note. They often have longer payment terms and may include interest.
- Other Receivables (or Non-Trade Receivables): This is a catch-all category for money owed from transactions outside of normal sales. Examples include tax refunds due from the government, interest receivable on loans, or advances to employees.
Valuation: What Are Receivables Worth?
Receivables are initially recorded at their full invoice amount. However, since it's likely that some customers will not pay, accounting standards require companies to report them at their Net Realizable Value (NRV).
The Allowance for Doubtful Accounts
To calculate the NRV, companies subtract an estimate of uncollectible accounts from their gross receivables balance. This estimate is held in a contra-asset account called the Allowance for Doubtful Accounts. By doing this, the balance sheet presents a more realistic picture of the cash the company actually expects to collect.
Importance for Liquidity and Credit Management
Receivables are a critical component of a company’s working capital and provide key insights into its financial health.
- Liquidity: As a current asset, receivables are a key source of liquidity. However, if collections are slow, too much cash can get tied up in receivables, straining the company's ability to pay its own bills.
- Credit Management: The size and age of receivables reflect a company's credit policies. A growing receivables balance could signal that the company is extending credit too loosely or is having trouble collecting from customers.
- Financial Ratios: Analysts closely monitor metrics like the accounts receivable turnover ratio and days sales outstanding (DSO) to measure how efficiently a company is collecting its receivables. A high turnover and low DSO indicate strong liquidity and effective credit management.
Key Takeaways
Receivables represent money owed to a company for goods or services it has already delivered on credit.
They are classified as a current asset on the balance sheet because they are expected to be converted into cash, typically within one year.
The main types are Accounts Receivable (from normal sales), Notes Receivable (formal IOUs), and Other Receivables (from non-sales activities).
Receivables are reported at their Net Realizable Value (NRV), which is the gross amount minus an Allowance for Doubtful Accounts to estimate for bad debts.
Managing receivables effectively is crucial for a company's liquidity and cash flow health, and is a key indicator of its credit management policies.
Related Terms
Receivables
A guide to understanding the money owed to a company by its customers and other parties, and how this asset impacts liquidity and financial health.
Receivables are amounts owed to a company by others (usually customers) for goods or services already delivered. In other words, when a business sells on credit, it creates a receivable - a claim on future payment. For example, if Company A sells $10,000 of goods on 30-day credit, it will record an accounts receivable of $10,000 until the customer pays. Because the seller expects to receive that cash later, receivables are recorded as assets on the balance sheet, typically as current assets since they are expected to be collected in the near term.
Table of Contents
Types of Receivables
While often used interchangeably with 'Accounts Receivable,' the term 'Receivables' can encompass several distinct types of claims:
- Accounts Receivable (or Trade Receivables): This is the most common type, arising from the ordinary course of business when a company sells its goods or services on credit.
- Notes Receivable: These are more formal credit arrangements backed by a signed promissory note. They often have longer payment terms and may include interest.
- Other Receivables (or Non-Trade Receivables): This is a catch-all category for money owed from transactions outside of normal sales. Examples include tax refunds due from the government, interest receivable on loans, or advances to employees.
Valuation: What Are Receivables Worth?
Receivables are initially recorded at their full invoice amount. However, since it's likely that some customers will not pay, accounting standards require companies to report them at their Net Realizable Value (NRV).
The Allowance for Doubtful Accounts
To calculate the NRV, companies subtract an estimate of uncollectible accounts from their gross receivables balance. This estimate is held in a contra-asset account called the Allowance for Doubtful Accounts. By doing this, the balance sheet presents a more realistic picture of the cash the company actually expects to collect.
Importance for Liquidity and Credit Management
Receivables are a critical component of a company’s working capital and provide key insights into its financial health.
- Liquidity: As a current asset, receivables are a key source of liquidity. However, if collections are slow, too much cash can get tied up in receivables, straining the company's ability to pay its own bills.
- Credit Management: The size and age of receivables reflect a company's credit policies. A growing receivables balance could signal that the company is extending credit too loosely or is having trouble collecting from customers.
- Financial Ratios: Analysts closely monitor metrics like the accounts receivable turnover ratio and days sales outstanding (DSO) to measure how efficiently a company is collecting its receivables. A high turnover and low DSO indicate strong liquidity and effective credit management.
Key Takeaways
Receivables represent money owed to a company for goods or services it has already delivered on credit.
They are classified as a current asset on the balance sheet because they are expected to be converted into cash, typically within one year.
The main types are Accounts Receivable (from normal sales), Notes Receivable (formal IOUs), and Other Receivables (from non-sales activities).
Receivables are reported at their Net Realizable Value (NRV), which is the gross amount minus an Allowance for Doubtful Accounts to estimate for bad debts.
Managing receivables effectively is crucial for a company's liquidity and cash flow health, and is a key indicator of its credit management policies.
Related Terms
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