What are Accounts Receivable?
Accounts receivable (AR) refers to the outstanding amount of money that customers owe a business for products that have been delivered but not yet paid for. If you close a deal and ship your products or give a customer immediate access to them, but payment has not been made, then that dollar amount would be referred to as AR.
Accounts Receivable vs. Accounts Payable
You likely hear the terms “accounts receivable” and “accounts payable” used around the office, but do you know the difference? While both refer to amounts of money, there are important distinctions.
AR refers to money that customers owe your company. It’s been billed out and is pending payment. Typically, customers are given a specific deadline for when payments must be made.
Accounts payable (AP) refers to money that your company owes its third-party vendors. If you purchased a product for your team to use on credit and have access to the tools but haven’t paid the bill yet, that dollar amount would be referred to as AP.
Why are Accounts Receivable Important?
Sales reps should know how much AR they’ve generated as it’s counted towards the total amount of revenue they and their teams are expected to make. Depending on a company’s policies, AR is either immediately counted towards revenue goals when the sale is finalized, or later when payment is officially received. In either case, it’s important for sales reps to know how much revenue each sale is expected to generate.
Finance teams record AR and keep track of both outstanding payments and money sent through to close out open credit accounts. If payments are not received, a member of the finance team sends out reminders, or coordinates with sales reps or account executives when services need to be canceled due to missed or lapsed payments.
AR is also recorded on a company’s balance sheet as an asset. Even though the payment is pending, it’s expected to come through and is recorded as so. If the payment isn’t processed accordingly, there are typically additional fees charged.
Most companies put specific timelines on AR. For example, a company can state that payments are expected to be made within 30 days, but exceptions can be determined on a case-by-case basis. This often happens for key accounts, or customers who make large or recurring purchases.
Accounts Receivable Turnover Ratio
An AR turnover ratio refers to the number of times a company receives its AR payments. It averages how many payments are received within a specific period (a month, quarter, or fiscal year).
You can calculate an AR turnover ratio using the following formula: net credit sales divided by average accounts receivable.
Knowing a company’s AR turnover ratio is important because it shows whether they’re able to collect payments owed to them by customers. If a company isn’t receiving payments they’re owed, there’s a serious problem that needs to be addressed and solved.
Ensuring quality customer satisfaction, timely follow ups, and an easy, straightforward payment system will allow for AR to be collected in a timely manner.