Accounts receivable - What are accounts receivable?
Accounts receivable is an amount that’s owed to a company by a customer who purchased goods or services on credit.
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Classified as a current asset, accounts receivable are short-term balances that are due for payment within an agreed-upon period of time. They’re the most liquid type of asset after cash.
An invoice that states specific payment terms such as 'net 60 days' is an indication that a sale was made from an account rather than with cash. The term 'net 60 days' means that the total invoice amount due is to be paid back at the end of the 60 day period.
The amount of accounts receivable is increased on the debit side and decreased on the credit side. When cash payment is received from the debtor, cash is increased and the accounts receivable is decreased. When recording the transaction, cash is debited, and accounts receivable are credited.
Accounts payable are recorded in a similar manner, but in the reverse roles - your company purchases goods or services on credit and increases the 'accounts payable'.
With automated invoicing software, like SumUp Invoices, the amounts are automatically adjusted and balanced when payment is received.
For example, Anna's Company sells £1200 of jewellery to a retailer who makes the purchase on credit. The retailer has 30 days to pay the full £1200 (net 30 days).
When the order is confirmed, Anna's Company decreases its inventory by £1200 and increases its accounts receivable by £1200. After 30 days, once the retailer has paid the £1200, Anna's Company increases its cash amount by £1200 and decreases its accounts receivable by £1200.
With invoicing software, the payment is automatically matched with the invoice and the reports are updated.
The purpose of the ratio is to measure the amount of time it takes for a company to collect their accounts receivable on an average basis. It's a measurement that allows insight into the efficiency of the company in terms of asset use. It’s usually performed annually.
The calculation for the turnover ratio is as follows:
Turnover Ratio = Net Credit Sales / Average Net Receivables
The length of the collection period is an important indicator of when a company can expect to receive cash and therefore provides an idea of the current liquidity situation.
For example, John's Company has a turnover ratio of 8, which means that the accounts receivable typically turn over 8 times each year, so John's Company collects its receivables every 45.6 days.
To determine the average number of days it takes for a company to collect accounts receivable, divide 365 (number of days in a year) by the ratio (8) to calculate the answer: in this case, 45.6 days.