Accounts receivable represent the amount of money customers owe a business for goods and services provided. Receivables usually comprise lines of credit extended to customers as a courtesy. Rather than paying vendors immediately, customers can make pay according to net terms. These terms may give customers an amount of time to pay that ranges from days to months.

Receivables as Incentives

Many retail customers want to buy from wholesalers who offer net terms, so those customers have time to sell the goods they buy for cash. Therefore, customers who have limited cash reserves or other cash flow issues will often pay more for products if they can defer payment by buying goods on account.

Businesses that sell on net terms may offer customers a cash discount for paying early. This incentive helps wholesalers and other B2B companies to minimize the cash flow problems that may result from having too many receivables on the books.

Receivables on the Books

Most of the time, businesses collect their accounts receivable within 60 days of a sale. This allows accountants to classify receivables as a current asset. On balance sheets, receivables usually appear beneath short-term investments and above inventory. Companies usually record receivables as the amount of cash the business expects to receive, an amount that can reflect sizable losses.

Receivable Problems

Businesses risk selling too many goods and services on customer accounts. This can result in serious cash flow problems. Receivables turnover, the ratio of credit sales to accounts receivable, tells managers and bankers how efficiently businesses collect their accounts. Low ratios suggest a company has too many low-quality customers who fail to pay their bills on time. Low receivable turnover ratios also identify companies that may experience cash flow problems.

When banks see companies that have poor turnover ratios, those institutions assume companies will never collect some receivables. This limits the ability of a company to borrow money and could have long-term repercussions. Therefore, businesses that decide to offer credit must only offer credit to their best customers to limit the risks associated with bad debt.

Receivable Costs

In ideal situations, the costs associated with receivables involve only opportunity cost. Businesses purchased products or supplies that were then furnished to a customer in anticipation of payment. While businesses await payment, they cannot use that money to pay bills, buy inventory, issue payroll or perform other tasks. Besides opportunity costs, accounts receivable represent expenses for account management as well as the cost involved with uncollectible receivables.

When companies realize that customers will not pay their bills, accountants must categorize associated receivables as bad debt. For tax purposes, businesses can use direct write-off procedures to deduct bad debts from their tax liabilities. Financial reporting standards do not allow direct write-offs, so businesses must follow the so-called allowance method. This approach to bad debts requires firms to estimate their bad debts at the end of every accounting period. Companies that have existed for a long time can estimate their bad debts based on historical averages. New businesses that accumulate receivables must use industry figures to estimate the amount of receivables they should write off.

Accutrac Capital Solutions offers factoring and accounts receivables solutions to help business structure their financing.

Accutrac Capital Solutions offers factoring and accounts receivables solutions to help business structure their financing. http://www.accutraccapital.com/

Author Bio: Accutrac Capital Solutions offers factoring and accounts receivables solutions to help business structure their financing.

Category: Finances
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